Digitized  by  the  Internet  Archive 
in  2007  with  funding  from 
IVIicrosoft  Corporation    ' 


http://www.archive.org/details/developmentofsciOOdetrrich 


^% 


The  Development  of 

Scientific  Rates /or 

Electricity  Supply 


Bein 


Printed  for  Private  Circulation  Only 

The  Edison  Illuminating  Company  of  Detroit 

1915 


/^^^?i- 
A^^^ 


*  '    NOTE.  (J 

Paragraph  headings  and  index  pages 
have  been  inserted  forconvenience.  The 
majority  of  these  headings,  and  the  in- 
dex pages,  are  not  in  the  original  papers. 


CONTENTS 

Page 

On  the  Cost  of  Electric  Supply 5 

By  Dr.  John  Hopkinson  (1892) 

A    Method   of   Calculating   the   Cost   of   Furnishing   Electric 

Current  and  a  Way  of  Selling  It 21 

By  W.  J.  Greene  (1896) 

Cost  of  Electricity  Supply 31 

By  Arthur  Wright  (1896) 

Equitable,  Uniform  and  Competitive  Rates 53 

By  Henry  L.  Doherty  (1900)  4 

High  Efficiency  Lamps — Their  Effect  on  the  Cost  of  Light 

to  the  Central  Station 79 

By  S.  E.  DoANE  (1910) 

Demand  and  Diversity  Factors  and  Their  Influence  on  Rates.    101 
By  J.  R.  Cravath  (1910) 

Effect  of  Width  of  Maximum  Demand  on  Rate  Making 115 

By  Louis  A.  Ferguson  (1911) 

Reasonable  Profit — Its  Definition,  Collection  and  Distribution  127 
By  James  V.  Oxtoby  (1910) 


741436 


On  the  Cost  of  Electric  Supply 


by 
Dr.  JOHN  HOPKINSON 


Presidential  Address  to  the 
Junior  Engineering  Society 

November  4th,  1892 


(From  the  Transactions  of  the  Junior  Engineering  Society, 
Vol.  Ill,  Part  I,  pp.  1-14) 


INDEX 

Page 

Introduction 7 

Standing  Costs  and  Running  Costs 8 

Load  Factor 8 

Apportionment  of  Costs 10 

Form  of  Charge 13 

Comparison  with  Costs  for  Gas ; 14 

Effect  of  Use  of  iVccumulators 15 

Effect  of  Use  of  Alternating  Current 19 

Conclusion 20 


On  the  Cost  of  Electric  Supply 

By  Dr.  John  Hopkinson 
1892 

Introduction 

The  interests  of  an  Engineer  are  many  sided.  If  he  is  to 
successfully  use  the  forces  of  nature  for  the  service  of  man  he  must 
understand  how  those  forces  work;  he  must  in  fact  be  scientific. 
It  may  be  that  his  ideas  are  arranged  differently  from  the  ideas  of 
those  who  study  science  for  its  own  sake,  and  without  regard  to 
practical  applications,  but  if  he  is  to  succeed  they  must  be  so  arrang- 
ed that  he  can  deduce  from  knowledge  already  acquired,  knowledge 
which  is  applicable  to  new  cases  which  have  not  as  yet  come  under 
his  observation.  The  Engineer  who  can  only  do  that  which  he  has 
seen  done  before  may  be  a  practical  man,  but  he  will  always  belong 
to  a  lower  grade  of  his  profession.  The  scientific  Engineer  is  one 
who  by  his  knowledge  of  nature  is  able  to  deal  with  new  engineering 
problems  and  provide  useful  solutions  of  those  problems.  But  a 
practical  man  must  be  something  more  than  a  man  of  science,  or 
rather  he  must  look  at  matters  from  a  different  point  of  view.  He 
cannot  choose  some  feature  of  a  problem,  concentrate  all  his  atten- 
tion upon  that,  and  leave  other  matters  out  of  consideration,  which 
is  the  process  by  which  most  scientific  advance  has  been  made; 
but  he  must  always  deal  with  the  whole  matter  before  him  and  leave 
no  relevant  question  out.  But  an  Engineer  may  be  scientific 
inasmuch  as  he  has  knowledge  of  nature  and  the  power  of  applying 
that  knowledge  in  new  cases;  he  may  be  practical  in  the  sense  that 
the  means  he  devises  to  attain  his  ends  may  be  complete  at  all 
points,  and  not  break  down  from  trifling  defects,  and  yet  may  find 
that  there  are  other  subjects  which  he  has  to  consider.  Our  com- 
plete Engineer  must  give  his  attention  to  commercial  matters  as 
well;  he  must  know  if,  when  he  has  devised  the  means  to  attain  the 
ends  in  view,  those  ends  when  attained  will  result  in  a  profit.  He 
must  recognise  the  conditions  which  render  an  undertaking  econ- 
omical to  work,  and  which  secure  that  it  shall  bring  in  a  large  return^ 


8  DEVEI^OPMENT  OF  SCIENTIFIC  RATES 

When  it  has  been  ray  lot  to  address  Engineers  I  have  usually 
directed  atleution  to  some  scientific  point  which  I  thought  would 
be  of  interest  to  them.  This  evening  I  should  like  to  go  to  the  other 
extreme  and  deal  with  a  purely  commercial  question,  with  a  matter 
into  which  no  science  enters,  and  which  relates  entirely  to  pounds, 
shillings  and  pence. 

Standing  Costs  and  Running  Costs 

You  are  all  of  you  familiar  with  the  fact  that  the  expenses  of  an 
undertaking  may  be  broadly  divided  into  two  classes.  On  the  one 
hand  there  are  expenses  which  are  quite  independent  of  the  extent 
to  which  the  undertaking  is  used,  and  on  the  other,  expenses  which 
are  absent  unless  the  undertaking  is  used  and  which  increase  in 
proportion  to  the  use.  For  example,  the  charges  for  interest  on 
the  construction  of  a  bridge  are  the  same  whether  that  bridge  is 
used  much  or  little  or  at  all,  and  the  cost  of  maintaining  the  bridge 
is  also  practically  independent  of  its  user.  The  same  is  true  in  a 
large  measure  of  a  harbour  or  a  dock.  Such  undertakings  lie  at 
one  extreme  of  the  scale.  It  is  less  easy  to  find  good  examples  at 
the  present  day  of  the  other  extreme,  as  nearly  all  undertakings 
with  which  Engineers  have  to  deal  require  the  employment  of  some 
capital,  and  there  will  be  a  fixed  charge  for  the  use  of  that  capital 
and  for  maintaining  against  the  assaults  of  time  the  things  in  which 
the  capital  is  embodied.  But  we  can  readily  see  for  example  in  the 
case  of  a  cotton  mill  that,  if  on  the  one  hand  there  are  expenses  for 
interest  and  dilapidation  which  are  independent  of  the  amount  of 
yarn  actually  manufactured  in  a  given  factory,  there  are  other 
expenses  for  material  and  labour,  and  even  for  actual  wear  of 
machinery  which  will  be  very  nearly  proportional  to  the  output. 
Undertakings  vary  enormously  in  the  proportion  of  these  two  classes 
of  expenses,  in  some  the  expense  is  quite  independent  of  the  extent 
of  the  user,  in  others  it  is  for  the  greater  part  proportional  to  the 
user. 

Load  Factor 

But  undertakings  differ  from  each  other  in  another  respect.  In 
some  cases  the  service  which  the  undertaking  is  designed  to  render 
can  be  performed  at  a  time  selected  by  the  undertakers;  in  others 
at  a  time  selected  by  him  to  whom  the  service  is  rendered.  In  the 
case  of  most  manufactures  it  matters  not  if  the  thing  made  is  made 
to-day  or  to-morrow,  in  the  morning  or  the  evening,  for  it  will  not 


ON  THE  COST  OF  ELECTRIC  SUPPLY       9 

be  used  for  a  month  hence  perhaps;  the  thing  can  in  fact  be  exten- 
sively stored  and  kept  till  it  is  wanted.  Other  services  must  be 
rendered  at  the  moment  the  person  served  desires.  For  example, 
the  Metropolitan  District  Railway  must  be  prepared  to  bring  in  its 
thousands  of  passengers  to  the  City  at  the  beginning  of  the  day  and 
to  take  them  back  in  the  evening,  and  for  the  rest  of  the  day  it  must 
be  content  to  be  comparatively  idle.  In  this  case  the  services  can- 
not be  stored.  The  line  must  be  of  a  carrying  capacity  equal  to 
the  greatest  demand,  and  if  this  be  great  for  a  very  short  time  the 
total  return  for  the  day  must  be  small  in  comparison  with  the 
expense  of  rendering  the  service.  In  such  a  case  it  would  not  be 
inappropriate  to  charge  more  for  carrying  a  person  in  the  busy  time 
than  in  the  slack  time,  for  it  really  costs  more  to  carry  him. 

Let  us  see  how  these  considerations  apply  to  the  supply  of 
electricity  for  lighting.  Electrical  Engineers  now  realise  that  they 
have  to  provide  the  same  plant  and  no  more  to  give  a  steady  supply 
day  and  night  as  to  give  a  supply  for  one  hour  out  of  the  twenty-four. 
They  also  now  realise  that  if  they  are  to  be  ready  to  give  a  supply 
at  any  moment,  they  must  burn  much  coal  and  pay  much  wages 
for  however  short  a  time  the  supply  is  actually  taken.  Indeed,  the 
term  "load  factor"  proposed  by  Mr.  Crompton  is  as  constantly  in 
the  mouths  of  those  who  are  interested  in  the  supply  of  electricity, 
as  volt  or  ampere  or  horse-power.  The  importance  of  the  time 
during  which  a  supply  of  electricity  is  used  was  so  strongly  impressed 
on  my  mind  years  ago  that  in  1883  I  had  introduced  into  the 
Provisional  Orders  with  which  I  had  to  do,  a  special  method  of 
charge  intended  to  secure  some  approach  to  proportionality  of 
charge  to  cost  of  supply.  Unfortunately  the  orders  of  that  day  all 
came  to  nought. 

A  supply  of  electricity  must  be  delivered  at  the  very  moment 
when  the  consumer  chooses  to  use  it,  and  as  long  as  and  no  longer 
than  he  pleases  to  use  it;  it  cannot  be  very  readily  or  cheaply  stored, 
and  much  of  the  cost  of  production  is  the  fixed  charge  for  plant  and 
conductors.  Furthermore  the  provisional  orders  require  that  the 
supply  shall  be  available  at  all  hours;  hence  coal  must  be  con- 
sumed and  workmen  must  attend,  though  but  few  consumers  are 
drawing  a  supply.  The  service  of  supplying  electricity  has  from 
an  economic  point  of  view  a  great  deal  of  similarity  to  the  service 
of  providing  a  breakwater  for  a  harbour.  A  great  deal  of  the 
expense  is  independent  of  the  number  of  hours  in  the  day  during 
which  the  supply  is  used.     To  put  it  in  another  way,  the  cost  of 


10  DEVELOPMENT  OF  SCIENTIFIC  RATES 

supplying  electricity  for  1,000  lamps  for  ten  hours  is  very  much  less 
than  ten  times  the  cost  of  supplying  the  same  1,000  lamps  for  one 
hour,  particularly  if  it  is  incumbent  on  the  undertaker  to  be  ready 
with  a  supply  at  any  moment  that  it  is  required. 

The  actual  importance  of  considerations  of  this  kind  can  only 
be  realised  by  examining  figures.  The  figures  may  as  well  be 
estimated  figures,  because  the  circumstances  vary  from  one  neigh- 
bourhood to  another.  No  criticism  of  the  details  of  the  figures 
will  affect  the  general  character  of  the  conclusion.  Let  us  then 
imagine  a  station  capable  of  supplying  40,000  sixteen-candle  lamps 
at  one  time,  with  mains  and  spare  machinery  enough  to  ensure  that 
the  supply  shall  not  fail,  and  let  us  see  what  the  charge  for  running 
such  a  station  will  be;  firstly  on  the  hypothesis  that  it  is  always  to 
be  ready  to  supply  the  40,000  lights  at  half-an-hour's  notice  day  or 
night  but  that  the  lights  are  hardly  ever  actually  required;  secondly 
on  the  hypothesis  that  the  40,000  lights  are  steadily  and  continu- 
ously supplied  day  and  night.  These  are  the  two  extreme  cases 
possible.  In  the  former,  the  load  factor  is  nil;  in  the  latter  it  is  100 
per  cent.  If  the  charge  is  by  meter  at  8d.  per  unit  in  the  former 
case,  the  revenue  will  be  nil;  in  the  latter  it  will  be  £730,000  a  year. 

Apportionment  of  Costs 

We  are  going  to  divide  the  cost  of  supplying  electricity  into  two 
parts;  a  part  which  is  independent  of  the  hours  the  supply  is  used, 
and  a  part  which  is  directly  proportional  thereto;  and  we  are  going 
to  estimate  the  amount  of  each  element.  It  is  for  the  purpose  of 
ascertaining  these  elements  that  we  consider  two  quite  hypothetical 
cases;  cases  which  can  themselves  never  actually  occur. 

We  must  first  have  an  idea  of  the  capital  outlay  required.  To 
provide  the  maximum  of  40,000  lamps  we  need  to  deliver  2,500  units 
per  hour,  and  we  may  estimate  the  capital  outlay  as  follows: — 

£ 

Land 25,000 

Buildings 15,000 

Boilers  and  Pipes 14,000 

Engines 24,000 

Dynamos 15,000 

Switchboard  and  Instruments 2,000 

Feeders  and  Mains 50,000 

£145.000 


ox  THE  COST  OF  ELECTRIC  SUPPLY  11 

Let  us  deal  with  the  annual  charge  for  each  item  of  capital  sepa- 
rately on  the  two  hypotheses.  The  charge  for  land  and  for  buildings 
including  repairs  is  clearly  the  same  in  the  two  cases,  say  at  4  per 
cent.  £1,000  for  the  land,  and  at  10  per  cent.  £1,500  for  the  buildings. 
The  boilers,  engines,  and  dynamos  will  have  a  charge  for  interest, 
and  a  charge  for  writing  off  or  amortization  as  the  French  call  it, 
that  is,  for  writing  off  the  value  of  the  plant  before  the  time  at  which 
it  becomes  antiquated — exactly  the  same  in  the  two  cases.  The 
boilers  too  will  require  exactly  the  same  repairs  whether  they  are 
merely  keeping  steam  or  whether  they  are  generating  steam  con- 
tinuously; but  the  machinery  will  certainly  require  more  for  repairs 
and  renewals  if  it  is  all  running  than  if  a  part  only  is  running 
without  load  and  the  rest  is  standing  ready  for  a  load  if  required. 
I  take  4  per  cent,  as  the  charge  for  interest;  3  per  cent,  for  amortiza- 
tion; 8  per  cent,  for  repairs  and  maintenance.  Of  the  repairs  of 
engines  and  dynamos  I  assume  that  '^  per  cent,  will  be  applicable  if 
the  plant  runs  light,  the  remaining  6  per  cent:  if  it  is  fully  and 
continuously  loaded.  The  expenses  connected  with  conductors  and 
switchboard,  etc.,  will  be  exactly  the  same  whether  the  current  is 
passing  or  not;  these  I  take  at  15  per  cent.  The  rates  I  put  down  at 
£500  a  year.  The  account  then  for  the  fixed  charges  already 
enumerated  would  stand  as  follows: 

Running  Light     Fully  Loaded 
£  £ 

Land 1,000  1,000 

Buildings 1,500  1,500 

Rates 500  500 

Boilers 2,100  2,100 

Switchboard  and  Conductors 7,800  7,800 

Engines 2,160  3,600 

Dynamos 1,350  2,250 

£16,410  £18,750 

We  now  come  to  a  most  important  item  in  the  account,  the  coal. 
There  is  no  doubt  that  with  uniform  and  continuous  load  a  unit  of 
electric  energy — iH  horse-power  for  one  hour — can  be  produced  \ 
for  less  than  3  lbs.  of  coal;  it  is  also  pretty  much  admitted  that  with 
a  load  factor  of  about  12  per  cent.,  but  continuous  maintenance  of 
pressure,  the  consumption  of  coal  in  good  practice  is  something 
like  7  lbs.  That  is  to  say,  to  keep  the  boilers  warm,  turn  round  the 
machinery  for  24  hours,  and  deliver  full  current  for  24  hours,  will 
require  72  lbs.  of  coal  per  kilowatt;  whereas  to  keep  the  boilers  warm, 
turn  round  the  machinery,  and  deliver  current  for  3  hours,  will 


12  DEVELOPMENT  OF  SCIENTIFIC  RATES 

require  21  lbs.  of  coal.  The  boilers  being  kept  warm,  it  will  take 
51  lbs.  of  coal  to  generate  steam  enough  to  give  a  unit  per  hour  for 
21  hours;  58  lbs.  to  give  a  unit  per  hour  for  24  hours;  subtracting 
this  from  72  lbs.,  the  amount  required  both  to  generate  steam  and 
keep  the  boiler  warm,  we  may  infer  that  to  keep  the  boiler  warm  and 
merely  turn  the  machinery  in  readiness  to  meet  a  demand  will  take 
about  14  lbs.  of  coal  per  day  for  every  unit  per  hour  the  plant  is 
capable  of  producing.  In  1889,  for  the  Society  of  Arts,  tests  were 
made  of  a  Paxman  compound  engine,  from  which  it  appears  that  a 
boiler  which  when  fully  loaded  consumed  40  lbs.  of  coal  per  hour, 
required  4  lbs.  per  hour  to  keep  steam  up  to  normal  pressure  when 
the  engine  was  standing:  that  is,  10  per  cent,  of  the  coal  used  was 
used  to  maintain  the  steam  pressure.  Remembering  that  in  addi- 
tion we  keep  some  of  our  machinery  moving,  this  may  be  said  to 
confirm  the  figures  adopted.  Thus  if  the  plant  runs  light  all  the 
year  round  12,775,000  lbs.,  or  let  us  say  6,000  tons  of  coal  will  be 
consumed.  If  the  plant  runs  fully  loaded  65,700,000  lbs.,  or  let  us 
say  30,000  tons  would  be  consumed.  If  we  suppose  the  coal  to  be 
best  smokeless  it  might  cost  20s.  per  ton. 

Next  we  have  water,  oil  and  petty  stores;  say  £600  and  £3,000 
in  the  two  cases.  Wages  will  be  a  Httle  less  if  we  run  light  than  if 
we  run  fully  loaded,  and  of  course  will  largely  depend  on  local 
circumstances;  let  us  say  £5,000  and  £7,500  in  the  two  cases.  This 
gives  us  substantially  all  the  expenses  which  have  to  be  met  and 
our  account  will  then  stand  thus: 

Running  Light  Fully  Loaded 
£  £ 

Fixed  Charges 16,410  18,750 

Coal 6,000  30,000 

Stores 600  3,000 

Wages 5,000  7,500 

£28,010  £59,250 

Thus  the  cost  of  merely  being  ready  to  supply  2,500  units  per 
hour  at  any  moment  throughout  the  year  will  be  £28,010,  and  the 
cost  of  actually  supplying  2,500  units  per  hour  for  every  minute 
in  the  year  will  be  £59,250.  The  undertaker  therefore  who  incurs 
the  liability  to  supply,  ought  to  receive  £11  per  annum  per  unit 
per  hour  from  those  on  whose  behalf  he  incurs  the  liability,  and  if 
he  receives  the  £11  he  need  not  charge  more  than  /^d.  per  unit  for 
what  he  actually  supplies,  to  cover  his  expenses.  That  these 
figures  are  fair  approximations  can  be  seen  as  follows:    according 


ox  THE  COST  OF  ELECTRIC  SUPPLY      13 

to  this  calculation  the  cost  of  supplying  2,500  units  for  one  hour 
per  day  is  £28,010+ 2,500  X  365  X>^d.  =  £29,277,  and  the  charge 
for  the  service  at  8d.  a  unit  would  be  £30,417;  it  is  doubtful  if 
such  a  supply  would  pay.  On  the  other  hand  an  indicated  horse- 
power on  such  a  scale  could  certainly  be  supplied  continuously  for 
from  £12  to  £14  per  annum,  and  according  to  this  calculation  an 
electrical  horse-power  will  cost  just  under  £18  per  annum.  No 
account  is  taken  of  expenses  peculiar  to  companies,  such  as  directors' 
fees  and  the  cost  of  forming  the  company.  It  will  also  be  noted 
that  it  is  assumed  that  accumulators  are  not  used. 

Form  of  Charge 

The  charge  for  a  service  rendered  should  bear  some  relation  to 
the  cost  of  rendering  it.  If  it  is  a  matter  of  open  competition  the 
matter  will  settle  itself,  for  no  one  will  for  long  be  able  to  supply 
some  customers  at  a  loss,  and  recoup  himself  by  exorbitant  profits 
from  others.  If  the  matter  be  a  case  more  or  less  of  monopoly, 
the  adjustment  is  less  certain;  thus  the  Post  Office  charges  Hd. 
postage  for  a  printed  circular  and  Id.  for  a  written  letter,  the  two 
costing  the  Post  Office  exactly  the  same.  What  a  boon  to  the 
public  it  would  be  if  the  Post  Office  would  charge  more  for  printed 
trade  circulars,  which  in  nine  cases  out  of  ten  are  a  nuisance  to 
those  who  receive  them.  The  supply  of  electricity  is  not  quite  'a 
monopoly;  companies  compete  with  each  other,  and  there  is  always 
the  competition  with  other  methods  of  illumination  such  as  gas  and 
paraffin.  It  is  clearly  to  the  advantage  of  the  undertaker  to  secure 
all  those  customers  whom  it  pays  best  to  supply,  and  as  far  as  may\ 
be,  to  compel  those  who  are  unremunerative  to  adopt  these  other 
methods.  The  ideal  method  of  charge  then  is  a  fixed  charge  per 
quarter  proportioned  to  the  greatest  rate  of  supply  the  consumer 
will  ever  take,  and  a  charge  by  meter  for  the  actual  consumption. 
Such  a  method  I  urged  in  1883,  and  obtained  the  introduction  into 
certain  Provisional  Orders  of  a  clause  sanctioning  "a  charge  which  is 
calculated  partly  by  the  quantity  of  energy  contained  in  the  supply 
and  partly  by  a  yearly  or  other  rental  depending  upon  the  maximum 
strength  of  the  current  required  to  be  supplied."  In  fixing  the  rates 
of  fixed  charge  it  must  not  be  forgotten  that  it  is  improbable  that  all 
consumers  will  demand  the  maximum  supply  at  the  same  moment 
and  consequently  the  fixed  charge  named  might  be  reduced  or  some 
profit  be  obtained  from  it.  There  is  no  object  in  reducing  the  cost 
of  electricity  for  lighting  in  the  case  of  any  customer  much  below 


14  DEVELOPMENT  OF  SCIENTIFIC  RATES 

the  cost  of  equivalent  lighting  by  gas,  unless  there  are  competitors  in 
the  field  willing  to  do  it,  hence  the  current  charge  proportioned  to 
the  power  supplied  may  safely  be  increased.  In  certain  recent  cases 
in  which  I  am  acting  as  engineer,  the  Board  of  Trade  have  sanctioned 
on  my  application,  "for  each  unit  per  hour  in  the  maximum  power 
demanded,  a  charge  not  exceeding  £3  per  quarter,  and  in  addition 
for  each  unit  supplied,  a  charge  not  exceeding  two  pence."  It  is 
sometimes  said  as  an  objection  to  this  method  of  charge,  the  public 
will  object  to  pay  a  fixed  charge  whether  they  make  use  of  their 
lights  or  not,  and  that  in  fact  they  will  not  pay  it.  The  best  answer 
that  can  be  made  is  to  give  everyone  the  choice  of  being  charged 
the  maximum  simple  rate  provided  by  the  Order,  or  by  the  com- 
pound rate,  as  they  prefer.  What  is  wanted  is  not  so  much  an 
increased  charge  for  those  consumers  whose  lights  are  used  for  a  short 
time,  as  such  a  special  reduced  charge  for  those  whose  lights  are 
used  long  as  will  induce  them  to  use  the  supply. 

Comparison  with  Costs  for  Gas 

It  is  instructive  to  compare  the  cost  to  different  classes  of  con- 
sumers of  electricity  and  gas  for  lighting  with  16-candle  gas.  Flat 
flame  burners  must  be  large  and  of  first-rate  quality  to  give  more 
than  two  candles  per  cubic  foot  of  gas  per  hour;  the  large  majority 
of  burners  give  much  less  than  this  even  at  their  best,  and  as  a  rule 
the  pressure  of  the  gas  is  not  regulated  and  much  gas  is  wasted  as 
far  as  the  production  of  light  is  concerned.  Incandescent  lamps 
give  about  one-quarter  of  a  candle  per  watt;  hence  a  Board  of 
Trade  unit  is  equivalent  to  125  cubic  feet  of  gas.  Thus  we  readily 
arrive  at  the  following  comparative  table,  the  charge  being  at  the 
rates  recently  sanctioned  by  the  Board  of  Trade: — 

Price  of  Gas  at  which 

cost  of  lighting  by 

electricity  and 

16-candle  gas  are  equal 

OS.         4d. 


Hours  oj 

I  use 

per  annum 

Load  Factor 

480 

5-5 

960 

■     10-9 

1,440 

16-4 

1,920 

21-9 

2,880 

32-9 

3,840 

43-8 

7,680 

87-6 

3s. 

4d. 

2s. 

8d. 

2s. 

4d. 

2s. 

Od. 

Is. 

lOd. 

Is. 

7d. 

In  the  accompanying  curves  are  shown  the  cost  of  production, 
and  the  charge  per  unit  at  the  compound  and  simple  rate.  The 
ordinates  represent  pence  and  the  abscissae  the  number  of  hours 
per  annum  the  supply  is  used. 


ON  THE  COST  OF  ELECTRIC  SUPPLY 


15 


It  is  obvious  that  those  whose  user  is  long  will  find  the  electric 
light  economical  to  themselves  and  that  it  will  be  profitable  to  the 
undertaker.  With  a  cheap  light  which  is  free  from  the  products 
of  combustion  there  will  be  extensions  for  the  hours  of  use.  Shops 
may  find  it  worth  while  to  continue  the  light  after  closing,  as  an 
advertisement. 


fH. 

/  n 

8 

1 

1    1 

9c/- 

/o«r  c/nt'-h 

Uj  6 

\ 

\ 

\\ 

t 

V 

\^ 

\ 

V 

!^ 

r"^ 

Z 

s 

^*" 

■"— 



|^>PCjC//7^  CA^^^ 

< 

"^ 

^ 

^_^ 

-£ 

X3/ 

1                   ' 

/jr-^,'^ 

0 

r 

f^ 

r 

/poo       ZOOO    3000      ^ooo     Sooa     6ooo      ?ooo    8000 
/fouA9  '  >  >  * 


Effect  of  Use  of  Accumulators 

We  have  so  far  assumed  that  the  supply  of  electricity  is  carried 
on  without  the  aid  of  accumulators.  Let  us  first  compare  the  cost 
of  an  electric  accumulator  with  the  cost  of  a  gas-holder  containing 
the  same  possibility  of  producing  light.  A  gas-holder  is  at  present 
being  put  up  in  Manchester  to  hold  7,000,000  cubic  feet  of  gas  and 
is  to  cost  complete  with  its  tank  £60,000.  With  16-candle  gas 
seven  million  cubic  feet  are  equivalent  to  56,000  Board  of  Trade 
units.  Accumulators,  capable  of  storing  a  ten  hours'  supply,  cost 
about  £50  per  unit.  The  equivalent  accumulator  will  therefore 
cost  about  £^280,000.  But  this  is  not  all;  the  gas-holder  is  compara- 
tively permanent;  the  accumulators  require  frequent  renewals  and 
repairs;  the  gas-holder  gives  back  all  the  energy  put  into  it;  the 
accumulators  waste  at  least  '20  per  cent.;  the  gas-holder  may  be 
emptied  as  fast  as  you  please;  the  accumulators,  not  faster  than  a 
certain  rate  without  diminishing  their  capacity.     Taking  all  into 


16  DEVELOPMENT  OF  SCIENTIFIC  RATES 

consideration,  the  cost  of  storing  energy  by  the  aid  of  accumulators 
and  storing  it  in  a  gas-holder  are  quantities  of  a  different  order  of 
magnitude.  If  no  gas-holders  were  used,  and  all  the  gas  had  to  be 
made  just  as  it  was  wanted,  its  cost  for  lighting  would  be  several 
fold  what  it  now  is,  even  if  gas-producers  could  be  found  capable  of 
instantly  varying  the  supply  as  the  demand  varies.  The  gas- 
producing  plant  would  have  to  be  enormously  increased;  so  would 
the  size  of  the  mains,  and  so  would  the  wages  of  labour.  If  electric 
power  could  be  stored  as  cheaply  as  gas,  there  would  soon  be  little 
hope  that  the  gas  companies  would  maintain  their  dividends. 

Let  us  see  from  a  financial  point  of  view  whether  accumulators 
can  be  used  economically  for  storing  up  electrical  power  continu- 
ously produced  during  the  24  hours,  and  used  rapidly  for  a  short 
time. 

Assume  that  the  whole  of  the  plant  with  the  accumulators  is 
capable  of  supplying  40,000  lights  for  ten  hours  continuously,  and 
that  during  that  time  half  the  power  is  supplied  from  the  accumu- 
lators. Ten  hours  in  the  twenty -four  hours  is  not  an  unreasonable 
allowance,  for  we  have  melancholy  experience  in  London  of  con- 
tinuous fog  for  days,  and  this  would  tax  the  plant  we  are  considering 
to  the  utmost.  We  are  to  be  ready  then  at  any  time  on  short 
notice  to  supply  40,000  lights,  and  to  continue  to  supply  them  for 
10  hours.  Compare  the  cost  firstly  of  maintaining  this  state  of 
readiness  with  the  accumulators  and  with  a  plant  without  accumu- 
lators. We  shall  require  a  battery  capable  of  giving  1,250  units 
for  ten  hours;  such  a  battery  costs  not  less  than  £50  per  uni.,  or  in 
all  £62,500.  To  maintain  it,  will  cost  from  10  to  15  per  cent,  on 
the  cost;  there  will  also  be  interest  on  the  outlay  and  amortization, 
say  in  all  20  per  cent,  or  £12,500  a  year.  If  we  assume  that  the 
batteries  are  distributed  at  the  various  points  of  the  system  of  con- 
ductors, we  may  also  assume  that  the  charges  for  land  and  buildings 
will  be  much  the  same  as  for  the  plant  without  accumulators.  The 
boilers,  engines,  and  dynamos  will  be  just  one-half.  The  switch- 
board and  instruments  will  be  much  the  same.  But  the  conductors 
will  be  reduced,  smaller  or  shorter  feeders  being  necessary,  probably 
£40,000  will  go  as  far  with  accumulators  as  £50,000  without.  The 
coal  bill  may  be  dispensed  with  entirely,  as  we  may  assume  that 
steam  could  always  be  got  up  during  the  time  in  which  the  demand 
increased  from  nothing  to  one-half  of  the  maximum,  and  that 
therefore  all  the  coal  burned  can  be  assumed  to  be  burned  for 
producing  current.     That  is  to  say,  we  assume  the  quantity  of  coal 


ON  THE  COST  OF  ELECTRIC  SUPPLY  17 

burned  is  proportional  to  the  quantity  of  electric  energy,  and  that 
therefore  when  no  electricity  is  actually  used,  no  coal  will  be  burned. 
The  wages  may  be  reduced,  for  we  have  only  to  be  ready  to  run  half 
the  plant,  and  a  small  wage  will  suffice  for  attendance  on  the 
accumulators.  The  wages  of  linesmen  and  the  like  will  remain  the 
same.  Assume  the  total  wages  to  be  £3,500  instead  of  £5,000. 
The  account  will  then  stand  thus: — 

£ 

Land 1,000 

Buildings 1,500 

Rates 500 

Accumulators 12,500 

Boilers 1,050 

Engines 1,080 

Dynamos 675 

Switchboard 300 

Conductors 6,000 

AYages 3,500 

£28,105 
practically  the  same  result  as  we  obtained  before. 

Now  consider  another  hypothetical  case,  which  of  course  can 
never  occur  in  practice.  We  are  to  supply  40,000  lamps  for  ten 
hours  every  day  with  the  plant  just  described,  charging  the  accumu- 
lators during  twelve  and  a  half  of  the  fourteen  hours  during  which 
the  light  is  not  required,  twelve  and  a  half  hours'  charging  giving 
ten  hours'  discharge  of  the  same  energy.  The  coal  would  cost  the 
half  of  £30,000  if  the  machinery  had  to  run  the  whole  of  the  24  hours. 
It  has  to  run  22^  hours,  but  the  boilers  have  to  be  kept  warm  the 
whole  time,  hence  the  coal  w\\\  cost  the  half  of  £6,000  for  keeping 
the  boilers  warm,  and  -^  of  the  half  of  £24,000  for  generating 
steam.  The  wages  may  fairly  be  taken  as  £4,750,  and  the  ac- 
count will  stand: — 

£ 

Land 1,000 

Buildings 1,500 

Rates 500 

Accumulators 12,500 

Boilers 1,050 

Engines 1,800 

Dynamos 1,125 

Switchboard 300 

Conductors 6,000 

Wages 4,750 

Coal 14,250 

Stores 1,425 

£46,200 


18  DEVELOPMENT  OF  SCIENTIFIC  RATES 

The  cost  of  supply  for  the  same  ten  hours  without  accumulators 
would  be  as  follows: — 

£ 

Land 1,000 

Buildings 1,500 

Rates 500 

Boilers 2,100 

Switchboard  and  Conductors 7,800 

Engines 2,760 

Dynamos 1,725 

Coal 16,000 

Stores 1,600 

Wages 6,000 

£40,985 

a  cost  of  about  11  per  cent,  less  than  where  accumulators  are  used. 

Putting  it  another  way,  the  cost  of  being  ready  to  supply  and  to 
continue  to  supply,  is  about  the  same  whether  accumulators  are 
used  or  not;  the  additional  cost  of  actually  supplying  current  is 
about  40  per  cent,  more  where  accumulators  are  used  than  where 
they  are  not  used.  It  may  be  safely  inferred  that  the  use  of  accu- 
mulators does  not  seriously  alter  the  conclusions  I  have  drawn  as 
to  the  proper  method  of  charging  consumers  for  a  supply  of  elec- 
tricity. 

The  question  of  whether  the  great  cost  of  a  supply  for  short 
hours  can  be  removed  by  the  use  of  accumulators  may  be  looked 
at  in  another  way.  Will  it  pay  a  consumer  to  put  in  his  own 
accumulators  and  charge  them  from  the  station  supply.'^  We  may 
reasonably  suppose  the  undertaker  will  remit  the  fixed  charge  in 
consideration  of  the  consumer  only  taking  his  current  at  slack 
times.  His  accumulators  if  they  are  to  be  of  capacity  to  maintain 
his  supply  through  a  foggy  day  will  cost  him  £50  per  unit  per  hour 
(or  per  kilowatt)  and  the  annual  charge  in  respect  of  them  will  be 
£10  per  year,  to  which  if  we  add  a  rent  for  the  space  the  battery 
occupies,  gives  us  a  charge  not  differing  materially  from  the  fixed 
charge  made  or  suitable  to  be  made  by  the  undertaker.  But  in 
order  to  obtain  2d.  worth  of  electricity  he  must  purchase  2/^d. 
worth  for  charging  his  battery. 

A  word  or  two  more  about  the  use  of  accumulators.  These 
have  certainly  improved,  and  they  will  continue  to  improve.  They 
will  become  more  durable  and  more  economical  of  power  in  working, 
and  their  first  cost  will  become  less.     An  inspection  of  my  tables  of 


ON  THE  COST  OF  ELECTRIC  SUPPLY  19 

cost  shows  that  a  very  Httle  improvement  would  render  them 
valuable  even  in  very  large  stations  for  the  mere  purpose  of  dimin- 
ishing the  machinery  required,  by  storing  the  energy  developed  at 
slack  times  to  be  used  in  busy  times.  The  certainty  of  improve- 
ments in  accumulators,  and  the  possibility  that  the  improvement 
may  be  considerable,  is  a  strong  argument  for  the  use  of  the  direct 
current  wherever  it  is  not  precluded  by  the  distance  of  transmission 
being  too  great. 

It  will  be  noted  that  I  have  assumed  a  very  large  station. 
Accumulators  have  another  use  which  greatly  increases  their  advan- 
tage in  smaller  stations.  There  are  many  hours  in  the  twenty -four 
when  it  is  absolutely  certain  that  the  demand  will  be  small.  If 
accumulators  are  used,  the  attendance  of  the  staff  may  be  dispensed 
\\4th  during  those  hours,  and  a  considerable  sum  in  wages  will  be 
saved.  The  proportion  of  wages  to  the  whole  of  the  charges  is  much 
greater  in  small  stations  than  in  large.  In  most  small  stations  giving 
continuous  supply,  accumulators  ought  to  be  used  notwithstanding 
their  expenses  and  defects,  and  I  believe  the  day  is  not  far  distant 
when  they  ought  to  be  used  in  connection  with  most  large  stations 
also. 

Effect  of  Use  of  Alternating  Current 

If  instead  of  a  continuous  current,  an  alternating  current  with 
transformers  is  used,  the  modification  in  the  account  will  be  that 
the  cost  of  conductors  will  be  diminished,  but  the  cost  of  trans- 
formers will  have  to  be  added.  If  the  distances  are  small,  the 
increased  cost  of  transformers  will  exceed  the  saving  in  the  con- 
ductors; if  the  distances  are  considerable,  the  cost  of  transformers 
will  be  less  than  the  saving  of  conductors.  In  both  cases  the 
general  character  of  the  result  will  be  the  same  as  before,  the  cost 
of  being  prepared  to  give  a  supply  will  be  considerable,  and  the 
cost  of  actually  giving  the  supply  will  be  much  smaller  than  is 
generally  supposed.  Indeed  with  the  alternating  current  this 
peculiarity  will  be  even  more  marked,  for  the  machinery  has  not 
only  to  be  kept  in  motion  however  small  the  consumption  may 
be,  but  a  certain  current  must  be  maintained  in  every  transformer. 
With  the  best  transformers,  this  current  may  only  have  an  energy 
1/^  per  cent,  of  the  energy  of  the  current  when  the  transformer  is 
fully  loaded.  This  would  increase  the  coal  bill  in  the  case  consid- 
ered by  about  £500  per  year  whether  the  supply  was  used  or  not. 


20  DEVELOPMENT  OF  SCIENTIFIC  RATES 

Conclusion 

It  is  possible,  indeed  probable,  that  some  of  my  assumed  figures 
may  be  shown  to  be  too  high  or  too  low  for  the  generality  of  cases. 
It  is  of  no  moment;  let  each  one  take  any  figures  he  pleases  within 
reason;  let  him  assume  that  the  supply  of  electricity  is  made  by  any 
system  he  pleases;  he  will  arrive  at  a  result  broadly  similar  to  mine. 
To  be  ready  to  supply  a  customer  with  electricity  at  any  moment 
he  wants  it  will  cost  those  giving  the  supply  not  much  less  than  £11 
per  annum  for  every  kilowatt,  that  is  for  every  unit  per  hour,  which 
the  customer  can  take,  if  he  wishes,  and  afterwards  to  actually 
give  the  supply,  will  not  cost  very  much  more  than  }id.  per  unit. 
This  is  the  point  I  have  been  labouring  to  impress,  for  I  take  it,  it 
is  essential  to  the  commercial  success  of  Electric  Supply.  It  is 
hopeless  for  electricity  to  compete  with  gas  in  this  country  all  along 
the  line,  if  price  is  the  only  consideration.  But  with  selected  cus- 
tomers, electricity  is  cheaper  than  gas.  Surely  it  is  the  interest  of 
those  who  supply  electricity  to  secure  such  customers  by  charging 
them  a  rate  having  some  sort  of  relation  to  the  cost  of  supplying 
them. 


A  Method  of  Calculating  the  Cost 

of  Furnishing  Electric  Current 

and  a  Way  of  Selling  It 

h 
W.  J.  GREENE 


(Repriated  from  The  Electrical  World,  Volume  XXVII, 
Feb.  29,  18%,  pp.  222,  223) 


INDEX 

Page 

Introduction 23 

The  Minimum  Charge 24 

Elements  of  Cost 24 

Apportionment  of  Costs 25 

Calculation  of  Cost  of  Current 25 

Form  of  Contract  for  Service 28 

Conclusion 29 


A  Method  of  Calculating  the  Cost 

of  Furnishing  Electric  Current 

and  a  Way  of  Selling  It 

By  W.  J.  Greene 
1896 

Introduction 

A  manager  of  a  central  station  has,  directly  or  indirectly,  two 
objects  in  view — the  increasing  of  the  revenue,  and  the  decreasing 
of  the  expenses.  A  thorough  knowledge  of  the  cost  of  supplying 
current,  and  of  the  rates  at  which  it  should  be  sold,  would  naturally 
come  under  the  first  head,  and  is  of  great  importance  in  insuring  the 
permanent  success  of  a  lighting  plant.  The  experience  of  the  writer's 
own  company  on  these  features,  and  data  formulated  therefrom, 
may  prove  of  some  interest. 

In  January,  1888,  the  company  commenced  the  supply  of  current 
for  light,  using  the  alternating-current  system.  In  the  Fall  of  1888 
a  few  meters  were  installed,  and  in  the  Spring  of  1889  the  use  of 
meters  was  adopted  exclusively,  except  for  one  or  two  lamps.  The 
rate  charged  was  one  cent  per  ampere-hour  on  oO-volt  current,  re- 
gardless of  the  amount  consumed.  Lights  were  added  very  rapidly. 
The  stockholders  were  continually  called  upon  to  provide  means  for 
enlargements  to  the  station  equipment,  extensions  to  the  circuits 
and  purchases  of  converters  and  meters.  The  net  earnings  for  a 
time  increased  in  proportion  to  the  increase  in  investments.  In 
1892,  however,  a  very  apparent  falling  off  in  the  net  earnings  in  pro- 
portion to  the  new  capital  invested  was  noticed.  It  became  evident 
that  something  was  wrong.  Tables  were  therefore  prepared,  show- 
ing the  expense  of  maintaining  an  equipment  necessary  to  supply 
current  for  consumers  having  from  one  light  and  upward.  In  com- 
paring these  results  with  the  actual  receipts  from  the  various  con- 
sumers, it  was  found  that  only  25  per  cent  of  residence  consumers 
and  55  per  cent  of  other  classes  used  sufficient  current  to  furnish  a 
paying  investment.  A  few  years  prior  thereto  fully  85  per  cent  of 
residence  consumers  and  95  per  cent  of  other  classes  were  considered 
profitable. 


24  DEVELOPMENT  OF  SCIENTIFIC  RATES 

The  Minimum  Charge 

To  find  that  too  much  business  was  undermining  the  stabiHty 
of  the  company  and  jeopardizing  its  success  was  startHng.  It 
was  evident  that  radical  changes  in  the  method  of  selHng  current 
must  be  made.  Various  plans,  suggested  by  the  practice  of  differ- 
ent companies,  were  considered,  and  it  was  finally  decided  to  adopt 
the  custom,  more  or  less  prevalent,  of  making  a  minimum  charge, 
the  charge  to  be  a  sufficient  amount  to  cover  all  expenses  known  to 
be  incurred  in  adding  a  consumer.  In  these  expenses  interest  on  the 
investment  and  an  amount  to  cover  depreciation  due  to  wear  and 
tear,  which  would  not  show  up  in  repairs  during  the  earlier  life  of 
the  plant,  were  included. 

Elements  of  Cost 

To  determine  the  least  amount  for  which  the  company  can  af- 
ford to  accept  consumers  it  is  necessary  to  establish  how  changes  in 
the  equipment,  consumers,  or  consumption  of  current  affect  the  ex- 
penses. I  have  made  the  following  groups  which  I  think  are  rea- 
sonably correct: 

First.  Expenses  affected  by  the  equipment,  from  real  estate  to 
meters,  and  expressed  by  the  relation  of  the  maximum  number  of 
lights  burned  at  one  time  during  the  year  to  the  investment. 

Second.     Expenses  affected  by  the  number  of  consumers. 

Third.  Expenses  affected  by  the  amount  of  work  done  by  en- 
gines, boilers,  dynamos,  etc.,  and  shown  by  the  output  in  watt-hours. 

Fourth.  Expenses  practically  unvarying,  and  practically  inde- 
pendent of  the  size  of  the  plant,  the  number  of  consumers  or  the 
amount  of  current  supplied.  These  may  be  considered  as  the  basic 
expenses,  or  the  starting  point  at  which  expenses  begin  to  increase 
more  or  less  in  proportion  to  any  increase  in  the  size  of  the  plant,  the 
number  of  consumers,  or  the  amount  of  current  generated.  They 
are  necessarily  estimated  expenses,  and  cover  the  cost  of  running 
the  station  with  a  unit  suitable  to  provide  for  the  day  load,  supply- 
ing current  to  the  switchboard  only.  The  company  must  depend 
on  long-hour  consumers  to  furnish  necessary  revenue  to  meet  these 
expenses.  This  fourth  group  is  divided  into  three  classes — those 
dependent  on  capital  invested  in  the  day  unit,  those  dependent  on 
the  management  of  such  a  unit  without  any  consumers,  and  those 
dependent  on  the  power  necessary  to  maintain  the  potential  at  the 
switchboard. 


METHOD  OF  CALCULATING  COST  OF  CURRENT   25 

Fifth.  Expenses  affected  by  the  size  of  the  meter  required  by 
the  individual  consumer.  The  meters  are  treated  separately,  be- 
cause the  size  of  the  meters  are  not  always  proportional  to  the  num- 
ber of  lamps  installed. . 

Apportionment  of  Costs 

The  first  group  comprises,  in  our  classification  of  accounts,  such 
expenses  as  total  charges,  exclusive  of  meters,  for  interest,  deprecia- 
tion, taxes,  insurance,  engineers  and  helpers,  building  repairs, 
switchboard  repairs,  station  wiring  repairs,  tool  and  instrument  re- 
pairs, circuit  repairs,  converter  repairs,  and  service  line  repairs. 

The  second  group  comprises  total  charges  for  management, 
clerical  service,  stationery  and  printing,  general  expenses,  petty 
repairs,  rents,  office  heating  and  lighting,  furniture  and  fixture  re- 
pairs and  reading  meters. 

The  third  group  comprises  total  charges  for  water,  fuel,  firemen 
and  helpers,  oil  and  waste,  boiler  compounds,  boiler  repairs,  pump 
repairs,  breeching  repairs,  piping  repairs,  engine  repairs,  shafting 
and  pulley  repairs,  belting  repairs  and  dynamo  repairs. 

The  fourth  group  comprises: 

First.  Two  engineers  at  nominal  wages,  interest,  depreciation, 
taxes,  insurance,  building  repairs,  switchboard  repairs,  station  wiring 
repairs  and  tools  and  instruments  repairs,  on  the  capital  invested 
in  the  smallest  unit  suitable  for  supplying  current  for  the  day  load. 

Second.  An  estimated  amount  from  charges  in  the  second 
group,  and  intended  to  be  an  amount  below  which  it  might  be  con- 
sidered such  expenses  could  not  be  reduced,  even  if  the  plant  were 
operated  without  a  consumer. 

Third.  Two  firemen,  water,  fuel,  oil  and  waste,  boiler  com- 
pound, boiler  repairs,  pump  repairs,  breeching  repairs,  engine  re- 
pairs, shafting  and  pulley  repairs,  belting  repairs  and  dynamo 
repairs,  necessary  to  keep  the  potential  at  the  switchboard  when 
running  the  smallest  unit  *24  hours  per  day. 

The  fifth  group  comprises:  Interest,  depreciation,  taxes,  insur- 
ance and  repairs  on  meters,  figured  on  the  size  of  meter  necessary 
for  any  desired  number  of  lamps. 


26 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


Calculation  of  Cost  of  Current 

For  simplicity,  the  following  letters  are  used  to  represent  the 
factors  employed  in  these  calculations: 

f  =the  first  group. 
C  =  the  second  group. 


W  =  ihe  third  group. 

/  =  the    first    division  under  the  fourth 

group. 
c  =  the  second  division  under  the  fourth 

group. 
u;  =  the  third  division  under  the  fourth 

group. 
A/  =  the  fifth  group. 
L  =  the    maximum    number    of    16-cp 

lamps  burned  at  one  time  during 

the  year. 
/  =  the  number  of  lamps   in   any   con- 
.     sumer's    installation    for    which 

the  cost  is  desired. 
e  =  the    energy    consumed     per    16-cp 

lamp  in  watts. 
N  =  the  number  of  consumers. 


T  =  the  total  annual  output  in  kw- 
hours  measured  at  station  switch- 
board. 

P  =  the  percentage  of  T  lost  in  converter 
and  line  leakage. 

I — P  =  the  percentage  of  T  used  by 
consumers  and  lost  in  transmis- 
sion, except  that  due  to  con- 
verter and  line  leakage,  as  pro- 
vided for  in  P. 

V=-the  eflSciency  of  transmission,  be- 
ing the  loss  in  conductors  and 
converters,  due  to  current  used 
by  consumers. 

VT  (l — P)  =the  amount  of  current  reg- 
istered by  consumers'  meters. 

X  =  the  minimum  cost  for  which  cur- 
rent can  be  supplied  for  /  lamps. 

Y  =  the  cost  for  /  lamps,  above  which 
the  company  can  afford  to  make 
concessions. 


Then: 

(1)    =    the  annual  cost  of  the  F — ■/  expenses  for  an   in- 

stallation of  /  lamps. 

IP{W—W)  .  ,  .       P.U        UZ  f 

(2)  — =   the  annual  cost  oi  the  n — w  expenses  tor  an 

installation  of  I  lamps. 


(3) 


N 


=   the  cost  of  the  C — c  expenses  per  consumer. 


(4) 


L  {F- 


-f)_  ^  IPjW- 


-w)_^C_ 


N 


-\-  M  =  The  least  annual 


amount  for  which  a  company  can  afford  to  accept  a  consumer,  if  he 
uses  no  current  at  all.  To  this  amount  must  be  added  the  cost  of 
the  W — w  expenses  for  a  quantity  of  current,  which  at  one  cent  per 
ampere-hour  will  equal  the  (4)  expenses  plus  the  W — w  expenses  for 
the  above  quantity  of  current.  This  is  found  by  dividing  (4)  by  one 
minus  the  W — w  expenses  per  ampere-hour. 


METHOD  OF  CALCULATING  COST  OF  CURRENT    27 

{W — w)  X  (I — P) 
(5)  —  ,        p. —  =  the  {W — 2v)  expenses  per  lamp-hour,  ex- 

^^ pressed  in  decimals  of  one  cent. 

e 

Hence : 


(6)     X  = 


l(F—f)  +  lP(W—ic)  ^  C—c  _^  jj 

~~  (W—w)  e 

^  ~        TV 


For  residence  lighting  /  give  /  a  value  of  3  for  5  lamps,  4  for  10 
lamps,  5  for  15  lamps,  6  for  20  lamps,  etc.;  because,  if  such  a  con- 
sumer wishes  to  have  provision  made  for  a  maximum  of  say,  20  lights, 
there  would  seldom  be  over  six  in  use  at  one  time  unless  an  enter- 
tainment were  taking  place,  in  which  case  other  places  could  be 
counted  on  to  cut  off  enough  lamps  to  make  up  for  the  difference 
between  the  estimated  maximum  and  the  agreed  maximum.  For 
the  value  of  Y,  I  add  to  the  interest  account  an  allowance  for  profits, 
and  to  the  depreciation  account  an  allowance  to  provide  for  depre- 
ciation, due  to  the  dropping  in  value  of  apparatus  and  improvements 
in  the  same,  which  may  necessitate  a  remodeling  of  a  plant  before 
the  original  machinery  is  worn  out.  The  estimated  expenses  of/,  c 
and  IV  are  made  zero,  and  thus  all  expenses  are  provided  for.  A 
factor  Z  is  introduced  to  allow  for  the  following: 

If  the  maximum  load  would  average,  say  four  hours  each  and 
every  day,  the  allowance  would  not  be  necessary,  because  every 
light  contracted  for  as  a  burning  light,  could  then  be  relied  upon  to 
earn  sufficient  to  pay  its  proportion  of  all  expenses.  The  minimum 
charge  could  then  be  made  the  same  as  the  charge  above  from  which 
discounts  could  be  made.  Few  plants,  however,  can  show  a  four- 
hour  maximum  peak,  and  the  conditions  of  operation  must  be  met 
by  dividing  the  expenses  not  included  in  the  minimum  charge,  among 
the  longer  hour  consumers.  I  endeavor  to  accomplish  this  and 
arrive  at  the  value  of  Z  by  dividing  the  average  maximum  four-hour 
load  in  December  by  the  average  maximum  four-hour  load  in  July. 

Hence : 

^IF-hlPW  C 

7 +  Y  +  3/ 

(7)  Y  =  Z  ^  ^ ^^^ 

^  ~  TV 


28  DEVELOPMENT  OF  SCIENTIFIC  RATES 

For  a  direct-current  plant,  P  would  be  so  small  that  the  W  ex- 
penses in  the  numerator  could  be  omitted  in  the  expressions  for 
both  X  and  F. 

By  putting  the  proper  expense  account  under  F,  C  and  W,  and 
letting  /  and  L  refer  to  arc  lamps  or  motors,  rated  in  watts  or  horse- 
power, the  formula  would  be  equally  applicable  to  arc  light  or 
power  service,  e  would  be  energy  in  watts  per  arc  lamp,  or  watts 
allowed  per  unit  adopted  in  motor  service. 

The  above  reasoning  or  formulas  may  not  be  absolutely  without 
error  or  faultless,  but  I  believe  that  they  are,  on  the  whole,  fairly 
correct,  and  the  information  to  be  obtained  therefrom  I  find  very 
valuable,  especially  in  competing  for  long-hour  consumers.  Data 
from  various  stations,  showing  the  expenses  per  lamp,  made  up  of 
expenses  that  vary  with  the  number  of  burning  lamps;  the  expenses 
per  consumer,  made  up  of  expenses  that  vary  with  the  number  of 
consumers;  the  expenses  per  kw-hour,  made  up  of  expenses  that 
vary  with  the  station  output;  and  the  percentage  of  the  output  lost 
in  converter  and  line  leakage,  would  surely  be  as  beneficial  to  man- 
agers as  the  collection  of  data  showing  the  watts  per  pound  of  coal. 

Form  of  Contract  for  Service 

Tables  made  showing  the  values  of  X  for  different  installations  of 
/  lamps,  give  the  minimum  charge;  and  similar  tables  for  Y  give  the 
charges  above  which  a  company  can  afford  to  make  concessions. 

The  following,  from  our  form  of  contract,  will  give  the  method  of 
selling  current  adopted  by  our  company : 

First  is  a  statement  showing  the  number  and  size  of  lamps: 

(1)  "Of  which  the  subscriber  agrees  to  burn  not  more  than 
lamps  of  16  candle-power,  or  equivalent,  at  any  one 


time. 


(2)     "The  subscriber  agrees  to  use  current  during  the  term  of 
year  from  the  time  connection  is  made,  and  pay  there- 


for on  or  before  the  10th  day  of  each  month  at  the  rate  of  one  cent 
per  ampere-hour  on  50- volt  current,  or  two  cents  per  ampere  hour  on 
100-volt  current,  as  may  be  shown  by  statement  of  the  meter. 

(3)  "The  subscriber  further  agrees  that  the  minimum  amount 
to  be  paid  for  current,  and  the  use  of  the  company's  apparatus,  other 
than  a  meter  of  the  ordinary  size,  under  this  application  and  con- 


METHOD  OF  CALCULATING  COST  OF  CURRENT   29 


tract,  shall  be  $_ 


per  year,  averaging  $. 


_  per  month,  and  the 
company  may  at  its  option,  render  and  collect  the  minimum  bill 
each  month,  in  which  case,  during  those  months  of  the  year  when 
more  light  is  required  and  consumed  by  him  than  the  minimum  bill, 
the  subscriber  will  be  credited  upon  his  monthly  bills  by  such  an 
amount  as  will  equalize  any  sum  paid  in  excess  of  the  amount  com- 
puted from  the  meter  reading,  providing,  however,  that  he  has  paid 
the  minimum  amount  of  this  contract  pro-rated  up  to  such  a  date." 

For  consumers  who  are  entitled  to  concessions,  the  following  is 
submitted  for  the  third  clause: 

*Tn  consideration  of  the  reduced  rates  herein  provided,  the  sub- 
scriber hereby  agrees  that  the  minimum  amount  to  be  paid  for  cur- 
rent in  any  month  shall  be  dollars. 

"The  company  agrees  to  make  discounts  on  bills  paid  before  the 
10th  day  of  each  month  as  follows: 

On  bill  of    2  times  minimum  bill,    5  per  cent. 


"     3 

10  " 

''     4 

15  " 

"     5 

20  " 

'*     6 

25  " 

"     8 

30  " 

"  10 

35  " 

*'The  minimum  charge  in  the  above  case  is  based  on  60  cents  per 
lamp  for  the  first  five  lamps  of  16-cp  or  equivalent,  and  on  30  cents 
per  lamp  for  each  additional  lamp  of  16-cp  or  equivalent." 

Conclusion 

Of  course,  this  method  is  not  as  popular  with  short-hour  con- 
sumers as  the  plan  of  charging  a  fixed  rate  per  unit,  regardless  of  con- 
sumption; but  the  plan  is,  without  question,  more  equitable  and  just 
to  all  concerned.  All  pay  the  increased  expenses  they  cause,  and  in 
this  way  the  long-hour  consumers  are  not  made  to  pay  for  the  losses 
otherwise  caused  by  the  short-hour  consumers.  It  is  also  possible 
to  make  concessions  without  encountering  the  dangers  to  be  met 
with  in  discounting  all  bills  of  a  certain  amount  or  over,  as  where 
all  bills  of,  say,  $10  per  month,  or  over,  are  discounted,  a  consumer 
having  100  lights  and  a  bill  of  only  $10  per  month  will  get  a  dis- 
count, whereas  he  should  have  created  a  bill  of  from  $20  to  $30  per 
month,  before  he  had  reimbursed  the  company  for  expenses  actually 
incurred  in  order  to  provide  him  with  light  subject  to  his  voluntary 
use. 


30  DEVELOPMENT  OF  SCIENTIFIC  RATES 

The  introduction  of  the  minimum  charge  has  checked  the  rapid 
rank  growth  which  was  bearing  Uttle  fruit  for  the  stockholders,  and 
has  given  in  its  place  a  healthy  and  satisfactory  increase  in  the  com- 
pany's business.  About  one  person  in  one  hundred  will  refuse  to  use 
the  light,  because  he  objects  to  the  minimum  charges,  on  principle. 
He  thinks  he  is  being  compelled  to  pay  something  for  nothing.  A 
just  and  reasonable  man,  however,  will  soon  see  the  fallacy  of  that 
argument.  None  will  connect  unless  they  either  expect  to  use  in 
excess  of  the  minimum  charge,  or  consider  the  light  has  sufficient 
value  to  make  it  worth  the  amount  of  the  charge.  A  net  increase  of 
about  2000  lights,  a  decrease,  with  the  above  lamps  added,  of  about 
200  lights  in  the  maximum  station  load,  and  a  very  satisfactory 
increase  in  the  gross  and  net  revenues  have  been  made  since  the 
adoption  of  the  minimum  charge. 


Cost  of  Electricity  Supply 


by 
ARTHUR  WRIGHT 


Presented  Before  Municipal  Electrical 
Association,  Whitehall,  England 

June  11th,  1896 


(Reprinted  from  Minutes  of  Municipal  Electrical 
Association,  18%,  pp.  1-8) 


INDEX 

Page 

Introduction 33 

Lack  of  Uniformity  in  Rate  Practice 33 

The  Hopkinson  Theory 34 

Determination  of  Standing  Costs  and  Running  Costs S6 

Study  of  Monthly  Expenditure  Curves 38 

Classification  of  Standing  Costs 40 

Standing  Costs  Proportional  to  Demand 41 

Comparison  of  Calculated  Costs  and  Actual  Costs 42 

Apportionment  of  Standing  Charges 43 

Diversity  Factor 44 

Load  Factor — Cost  Curves 44 

Differential  Rate 45 

Short  Hour  Consumers  Not  Profitable 46 

Profit  and  Loss  Account 47 

Conclusions 49 


Cost  of  Electricity  Supply 

By  Arthur  Wright 
1896 

Introduction 

No  manufacturing  undertaking  can  be  considered  to  trade  on  a 
sound  commercial  basis  unless  it  has  ascertained  to  some  degree  of 
accuracy  the  cost  of  supplying  the  commodity  it  produces.  That  the 
electricity  supply  business  at  present  can  hardly  be  said  to  pass  this 
criterion  of  commercial  soundness  the  author  thinks  will  be  generally 
admitted,  when  it  is  remembered  that  although  electricity  has  been 
regularly  supplied  for  over  five  years  from  many  large  undertakings 
in  quantities  exceeding  a  million  units  annually,  yet  at  the  present 
time  no  very  definite  basis  has  been  agreed  upon  by  which  the  cost 
of  energy  wasted  in  feeders,  transformers,  shunted  meters,  etc.,  can 
be  estimated,  or  on  which  to  arrange  tariffs  for  such  varying  classes 
of  consumers  as  street  lamps,  motors,  business  premises,  electric 
tramways  and  other  industries  consuming  the  electric  current. 

Lack  of  Uniformity  in  Rate  Practice 

To  illustrate  this  great  diversity  of  tariffs  and  presumably  the 
uncertainty  as  to  the  true  basis  for  costs  calculations,  the  author 
points  out  that  in  many  towns  discounts  are  given  in  proportion  to 
the  amount  of  electricity  consumed,  thus  assuming  that  the  cost  of 
supplying  electricity  depends  mainly  on  the  quantity  taken;  in 
other  towns  rebates  are  given  on  the  basis  of  the  time  of  the  day 
during  which  the  electricity  is  consumed,  or  on  the  lengthened  use 
of  the  lamps  or  plant  consuming  or  producing  the  electricity.  Again, 
in  others,  the  electricity  consumed  in  motors  is  charged  at  a  different 
rate  to  that  consumed  in  lamps,  implying  thereby  that  it  costs  less 
in  the  one  case  than  in  the  other.  Curious  instances  of  the  un- 
certainty of  opinion  on  this  subject,  which  is  of  the  first  importance 
to  Central  Station  Managers,  are  afforded  by  the  varying  and  often 
quite  arbitrary  figures  charged  for  the  electricity  consumed  in  public 
street  lamps,  and  by  the  compiler  of  Electricity  Works  Costs  in  a 
largely  circulated  technical  journal  who,  in  estimating  the  profit  or 
loss  made  on  the  supply  to  public  street  lamps,  has  actually  to  as- 


34  DEVELOPMENT  OF  SCIENTIFIC  RATES 

sume  the  cost  of  the  electricity  to  these  is  the  same  as  the  average 
cost  of  all  the  electricity  supplied  from  the  Central  Station. 

A  commercial  undertaking  supplying  only  one  commodity  such 
as  electricity,  ought  surely  to  be  able  to  show  from  its  books  where 
and  how  the  profits  or  losses  are  made.  Hitherto,  however.  Cen- 
tral Stations  have  had  to  be  judged  as  to  whether  they  are  successful 
or  not,  solely  on  the  net  results  of  the  year's  trading,  irrespective  as 
to  whether  the  profits  or  losses  were  made  from  all  the  consumers  or 
from  only  a  portion  of  them,  because  no  proper  method  of  keeping 
the  Profit  and  Loss  Account  has  been  as  yet  agreed  on  among  Cen- 
tral  Station   Managers. 

The  question  now  naturally  arises,  is  there  not  some  easy  and 
practical  method  for  doing  away  with  the  continued  guess  work  at 
the  cost  of  supplying  electricity  to  the  varying  classes  of  consumers 
which  is  so  often  resorted  to,  and  with  the  present  great  diversity 
of  systems  of  tariff. 

Of  the  many  proposed  methods  devised  for  arriving  at  a  solution 
of  the  complex  problem  of  determining  the  cost  of  supplying  elec- 
tricity, the  most  obvious  and  easy  is  the  usual  one  adopted  by  most 
of  us,  viz.:  that  of  dividing  the  total  annual  expenditure  or  the 
amount  debited  to  the  Revenue  Account  of  a  Central  Station  under- 
taking by  the  total  number  of  units  delivered  to  the  consumers,  and 
to  accept  this  actual  average  cost  per  unit  as  a  sufficient  guide  for 
all  purposes.  Many  business  men,  however,  now  recognise  that 
this  result  is  of  no  more  use  in  deciding  the  question  of  which  is  the 
correct  tariff  by  which  to  charge  the  various  classes  of  consumers 
than  would  be,  to  a  railway  manager,  the  knowledge  of  the  average 
cost  of  carrying  passengers  on  his  railway  per  mile,  should  he  want 
to  know  for  how  little  he  could  profitably  carry  a  certain  number  of 
excursionists  on  a  given  day. 

The  Hopkinson  Theory 

Dr.  Hopkinson,  in  his  classical  paper  before  the  Junior  Engi- 
neers, very  clearly  proved  that  the  cost  of  supplying  electricity  can- 
not he  correctly  defined  at  so  much  per  unit  unless  the  RA  TE  of  sup- 
plying that  unit  be  also  stated,  and  showed  that  the  cost  depends 
much  more  on  the  greatest  rate  at  which  the  electricity  has  to  be 
supplied  than  it  does  on  the  amount  actually  supplied.  He,  more- 
over, urged  that  it  was  both  morally  unjust  and  commercially  in- 
expedient to  always  charge  a  uniform  rate  for  a   manufactured 


COST  OF  ELECTRICITY  SUPPLY  35 

commodity  which,  in  one  case  might  very  obviously  require  ten 
times  as  much  plant  for  manufacturing  it  as  it  would  in  another, 
owing  to  its  having  possibly  to  be  supplied  at  ten  times  as  great  a 
rate. 

The  results  Dr.  Hopkinson  obtained  from  the  very  bold  method 
of  analysis  adopted  were  so  novel  and  surprising  that  perhaps  this 
may  account  for  so  many  of  us  still  ignoring  his  conclusions,  and 
partly  doubting  the  accuracy  of  his  method. 

Recently,  Mr.  Edison  and  Mr.  W.  J.  Greene,  in  America,  have 
attacked  this  problem  in  a  very  practical  spirit,  and  the  last-named 
gentleman  has  still  further  developed  the  theory  on  the  subject,  with 
the  result  of  arriving  at  practically  the  same  conclusions  as  Dr.  Hop- 
kinson as  to  the  correct  basis  on  which  to  frame  electricity  charges. 

As  far  as  the  author  is  aware,  no  one  has  hitherto  made  public 
the  results  of  applying  the  original  Hopkinson  method  to  actual 
accounts.  He  therefore  proposes  to  describe  modifications  of  the 
method,  and  the  results  of  analysing  by  them  the  figures  obtained 
from  the  central  supply  station  with  which  he  is  most  conversant, 
namely,  that  of  the  Brighton  Corporation. 

At  the  onset  he  stipulates  that  the  cost  of  supplying  electricity 
shall  be  understood  to  be  the  sum  of  all  the  items  necessarily  debited 
to  the  undertaking's  net  revenue  account,  or  that  it  is  equal  to  the 
amount  of  revenue  the  undertaking  must  earn  per  annum  for  it  to 
be  considered  self-supporting.  In  the  next  place,  it  must  be  under- 
stood that  the  methods  adopted  are  only  really  applicable  to  sta- 
tions which  have  got  into  full  working  order,  and  which  are  not 
either  over-capitalized  or  much  too  large  for  the  actual  business 
done,  but  which  can  be  extended  as  soon  as  the  increase  of  demand 
will  warrant  same;  and  in  such  a  business  as  that  of  electricity  sup- 
ply, it  is  essential  for  commercial  reasons  to  assume  the  supply  is 
taken  by  all  classes  of  consumers  for  at  least  one  year,  when  esti- 
mating the  total  cost  of  supplying  these  classes. 

Determination  of  Standing  Costs  and  Running  Costs 

If  monthly  or  quarterly  statements  be  made  of  the  total  ex- 
penses and  charges  debited  to  the  revenue  account  of  a  central  sup- 
ply station,  the  most  careless  observer  cannot  fail  to  notice  how 
very  slightly  the  total  expenditure  varies  during  the  different 
months  of  the  year,  although  the  output  or  sale  of  units  during  the 
different  months  may  vary  as  much  as  threefold. 


36  DEVELOPMENT  OF  SCIENTIFIC  RATES 

A  comparison  of  these  monthly  or  quarterly  statements  during 
a  period  when  the  output  has  considerably  varied,  furnishes,  in  the 
opinion  of  the  author,  the  most  correct  and  simple  method  for  de- 
termining those  portions  of  the  total  cost  of  supplying  electricity 
which  vary  with  the  number  of  units  sold,  and  which  are  conve- 
niently called  "running  costs"  in  contradistinction  to  the  "standing- 
by  costs,"  and  the  method  by  which  the  cost  of  supplying  any  class 
of  consumers  can  be  approximately  ascertained. 

In  the  first  place  it  may  be  observed  that,  as  regards  the  above 
divisions  of  the  total  expenditure  into  the  two  classes  of  running 
and  standing-by  costs,  in  actual  central  station  practice  only  the 
following  items  can  be  properly  included  under  the  head  of  running 
costs: — coal,  oil,  water,  and  a  few  other  engine  stores,  besides  those 
repairs  to  the  steam  and  electricity  generating  plant  which  are  caused 
by  the  continued  supply  of  electricity  to  consumers. 

Under  standing-by  costs  must  be  included  all  coal  and  oil  used 
in  getting  up  steam  and  in  keeping  the  machinery  and  mains  in  a 
position  to  supply  electricity  to  the  consumers  at  any  time,  also  all 
other  stores  used  in  the  station  or  on  the  mains,  all  the  wages  debited 
to  revenue  account,  as  in  practice  these  do  not  vary  from  month  to 
month  with  the  output  'of  electricity,  repairs  to  buildings,  mains, 
meters,  and  those  repairs  to  plant,  etc.,  which  are  due  to  it  having 
to  be  kept  in  a  position  to  supply  electricity,  all  rates  and  taxes, 
management  expenses,  insurances,  and  all  provisions  for  redemption 
of  capital  and  interest  on  same,  and  for  the  creation  of  any  reserve 
or  depreciation  fund  it  may  be  decided  to  form  for  the  purposes  of 
preventing  any  cessation  of  the  supply  at  any  future  time. 

Of  the  above  items  constituting  the  running  and  standing-by 
costs,  the  only  ones  which  are  not  capable  of  being  at  once  debited 
to  the  proper  division  are  the  coal,  stores,  and  repairs  of  plant,  but 
the  two  first  of  these  can  be  very  fairly  divided  by  the  use  of  the  fol- 
lowing simple  method  which  its  accompanying  formula  will  explain 
and  justify. 

Let  T  represent  the  total  expenditure  on  these  items  during  one 
month  or  period  of  time  when  the  sale  of  electricity  U  is  great,  and 
T  that  for  another  period  of  preferably  the  same  year  when  the 
sale  U     is  much  less. 

Let  S  be  the  cost  of  the  two  items  coals  and  stores  which  have  to 
be  used  during  each  of  the  two  periods  on  account  of  having  to  get 


COST  OF  ELECTRICITY  SUPPLY 


37 


ready  and  to  stand  by,  and  R  the  running  cost  per  unit  it  is  desired 
to  determine. 


Then  by  the  definition,  as  T  =  S  +  R  X  U 
and  T  '  =  S  +  R  X  U ' 

then  T  —  T  '  =  R  X  (U 


U') 


therefore  R  = 


T' 


U  — U 


7-andS  =  T  — R  X  UorT'— RxU' 


or  the  average  cost  per  unit  of  continuing  to  supply  electricity 
during  these  two  periods  is  the  difference  of  the  total  expenditures 
divided  by  the  difference  of  the  sales  in  the  two  periods. 

With  regard  to  the  item  of  plant  repairs  due  to  continued  supply, 
as  these  repairs  are  of  an  accumulative  nature,  it  is  advisable  to 
divide  the  total  of  all  items  of  repairs  obviously  due  to  having  to 
continue  generating  electricity  from  the  commencement  of  the  sup- 
ply by  the  total  number  of  units  since  supplied,  the  quotient  will  be 
then  a  fair  valuation  of  the  running  cost  per  unit  for  plant  repairs. 

To  illustrate  the  above  method  of  apportioning  items  involved 
both  on  account  of  running  and  standing-by,  the  following  state- 
ment referring  to  the  figures  of  the  Brighton  undertaking  will  be 
of  use: 


The  amount 
spent   in   coal 

Engine 
Stores 

The  units  sold 

during  these 

months 

In  the  three  months  of  October,  November 
and  December  in  1895 

£990 
365 

£201 
133 

366,040 
109,662 

In   the   three   months   of    May,    June   and 
Julv    .             • 

The  differences  between  the  figures  are ....          £625 

£68 

256,378 

Therefore,  by  the  above  rule  the  running  cost  for  coal  during  these 
six    months    was 


625  X  240 
256,378 


=  .584d.  per  unit 


T.        .,        ,  68   X   240 

roT  oil  and  stores   =  .063d.  per  unit 

256,378  ^ 


38 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


and  from  the  total  amount  spent  on  running  cost  repairs,  during  the 
four  years  the  central  station  had  been  in  full  working  order,  the 
author  finds  the  running  cost  repairs  averaged  at  the  end  of  1895 
,063d.  per  unit  sold.  Then,  as  the  running  costs  of  the  remaining 
six  months  of  1895  were  about  the  same  as  the  above  values,  by  this 
method  it  is  possible  to  arrive  at  a  very  fair  division  into  running 
and  standing-by  costs  of  the  items  on  the  debtor  side  of  the  Revenue 
Account  of  1895. 

Division  of  the  Debtor  side  of  the  Brighton  1895  Revenue  Ac- 
count into  Running  and  Standing-by  Items: 


Coal 

Stores 

Repairs  to  plant 

Repairs  to  buildings.  .  .  . 

Meters 

Mains 

Wages 

Rates  and  taxes 

Management 

Insurance 

Interest  &  Sinking  Fund 

Totals 


Rate  per 
unit  for 
running 
costs  de- 
termined 
by  above 
method 


d. 
584 
063 
063 


d. 
71 


Total 

running 

costs  for 

the  867500 

units  sold 


£ 
2,111 
230 
230 


£ 
2,571 


Total 
standing- 
by  costs 


£ 

■    485 

302 

147 

59 

69 

463 

1,719 

327 

1,838 

69 

7,777 


£ 
13,255 


Total 

amount 

spent  on 

the  items 

during 

1895 


£ 

2,596 

532 

377 

59 

69 

463 

1,719 

327 

1,838 

69 

7,777 


£ 
15,826 


As  the  annual  maximum  load  on  the  station  is  generally  increas- 
ing, the  mean  of  the  two  consecutive  years'  annual  maximum  loads 
is  taken  to  be  the  demand  on  the  Station,  in  calculating  the  standing- 
by  cost  per  kilowatt;  this  in  1895  was  £17.9  per  kilowatt  as  thus 
defined. 


Study  of  Monthly  Expenditure  Curves 

The  above  obtained  values  for  the  running  and  standing-by 
costs  at  Brighton  in  1895  are  closely  confirmed  by  quite  a  different 
method  to  be  presently  described,  based  on  the  analysis  of  the 
different  years'  expenditure  curves  into  the  different  terms  of  an 
equation  obtained  empirically. 


COST  OF  ELECTRICITY  SUPPLY 


39 


If  the  total  monthly  expenditures  as  above  defined  from  soon 
after  the  starting  of  the  undertaking  be  plotted  in  the  form  of 
a  curve,  such  as  the  dotted  one  shown  in  Fig.  1,  and  the  corres- 
ponding sale  of  units  be  plotted  alongside  this,  no  very  obvious 
connection  between  the  two  curves  will  be  discernible,  at  all  events 
certainly  nothing  like  the  uniform  price  system  of  charging  implies 
ought  to  exist.  If,  however,  the  maximum  annual  load  taken  off 
the  mains  be  plotted  on  the  same  diagram,  as  shown  by  the  crosses, 
with  a  suitable  scale,  and  these  points  or  crosses  be  connected  by 
straight  lines,  a  very  obvious  tendency  becomes  apparent  after  the 
first  or  second  year  for  the  monthly  total  expenditure  to  follow  this 
line  joining  the  points  representing  the  annual  maximum  loads  and 
the  slight  deviations  from  this  line  will  be  found  to  be  roughly 
proportionally  to  the  monthly  sales  of  electricity. 


'sopoc 

F,yi 

— 

n 

(40.0OC 

1       1       1       1        1       1       >        '       1 
Curves  shov^inarclatton 

I 

8, 

r 

IZO^OOO 

?W 

/%? 

imum  Load. 

1         !         1        i         I         . 

\ 

1 

i/oooc. 

«7* 

1 

1 

\ 

ino^  oot 

250< 

■    1 

/ 

' 

li.^ 

/ 

\ 

1 

aq.000 

Z09, 

n 
•^ 

i 

/ 

70^000 

17^ 

-^ 

/ 

6<^eoA 

I^OC, 

vS 

*\ 

'» 

f 

.jf^QSC 

ttS^ 

< 

/ 

'*w- 

\ 

:* 

■^" 

40O00 

'OVi 

^ 

/ 

/ 

f'^ 

\ 

1 

30,OQC, 

7S0 

L 

■X 

7 

\ 

J 

zoooo 

SOO 

' 

i 

^ 

\4' 

\ 

/ 

10000 

^99 

1 

\^. 

\j 

f5* 

\ 

^ 

<J 

a 

9 

%4 

y- 

r 

... 

/ef3 

IB 

?-* 

^^>_ 

IBi 

w 

/6 

9€ 

The  author,  after  studying  this  monthly  expenditure  curve  of 
the  Brighton  Station,  which  he  thinks  may  claim  to  be  one  fairly 
representative  of  economically  run  undertakings,  feels  convinced 
that  the  chief  governing  factor  in  determining  the  monthly  expendi- 
ture in  any  Central  Station  will  probably  be  found  to  be  the  maxi- 
mum annual  load  which  the  station  has  to  be  prepared  to  meet 
every  succeeding  year,  and  that  after  the  first  year  or  two,  the 


40  DEVELOPMENT  OF  SCIENTIFIC  RATES 

total  of  the  standing  charges  will  be  found,  for  all  practical  purposes, 
to  be  fairly  proportionate  to  this  maximum  annual  load. 

Classification  of  Standing  Costs 

Mr.  W.  J.  Greene,  in  the  paper  alluded  to,  has  pointed  out 
that  the  standing  charges  ought  theoretically  to  be  divided  into  the 
three  following  distinct  classes  of  expenditure: 

No.  1.  Those  due  to  the  preliminary  expenses  in  starting  the 
undertaking,  which  may  be  called  Basic  expenses. 

No.  2.  Those  depending  on  the  cost  of  connecting  the  con- 
sumers, called  Connection  costs. 

No.  3.  Those  proportional  to  the  total  maximum  simultaneous 
demand  of  the  Consumers  on  the  mains,  and  conveniently  called 
Demand  costs. 

With  regard  to  these  three  groups  into  which  the  standing 
charges  may  be  divided,  the  author  finds  that  the  following  is  the 
percentage  each  of  the  three  classes  bore  to  the  total  annual  expendi- 
ture incurred  after  the  Brighton  undertaking  had  been  worked  four 
complete  years: — 

The  Basic,  or  those  due  to  the  original  unproductive  outlay 
incurred  in  starting  the  undertaking,  constituted  6.3  per  cent,  of 
the  total.  Connection  costs,  or  those  due  to  the  cost  of  connecting 
consumers,  11  per  cent.  The  Demand  costs,  or  those  due  to 
having  to  be  ready  to  supply  the  annual  maximum  load,  66.4  per 
cent,  and  the  running  costs,  or  those  due  to  having  to  continue  to 
run  the  machinery  after  it  has  been  started,  16.3  per  cent. 

The  most  important  point  to  be  noticed  in  connection  with 
these  ratios  is  that  the  very  small  percentage  that  the  running  costs 
bear  to  the  total  in  such  a  town  as  Brighton,  viz.,  only  16.3  per 
cent,  would  obviously  be  very  much  smaller  if  coal  could  be  there 
obtained  at  say  10s.  per  ton,  the  price  paid  for  an  equivalent 
quality  in  some  of  the  northern  and  midland  towns,  and  in  that 
case,  instead  of  annual  standing  charges  being  about  five  times 
the  running  costs,  as  they  are  now  at  Brighton,  they  would  prob- 
ably be  quite  eight  and  a  half  times.  Hence,  there  is  obviously 
the  greater  necessity  for  a  differential  tariff  in  towns  where  coal  is 
cheap  than  where  it  is  dear,  as  at  Brighton. 

In  view  of  the  great  expense  of  connecting  consumers  and  of 
this  being  practically  independent  of  their  demand  or  consumption, 


COST  OF  ELECTRICITY  SUPPLY  41 

Mr.  Greene  strongly  advocates  the  system  of  making  a  minimum 
charge  per  annum  on  this  account,  as  well  as  on  account  of  their 
demand. 

Standing  Costs  Proportional  to  Demand 

The  author's  experience,  however,  tends  to  prove  that  the  sum 
total  of  the  three  classes  of  standing-by  expenses  follow,  as  a  rule, 
the  rising  line  connecting  the  annual  maximum  demands  on  the 
mains. 

This  near  proportionality  of  the  standing  charges  to  the  plant 
capacity  of  a  fairly  economically  run  station  may  be  a  surprise  to 
many  who  think,  as  the  author  was  formerly  inclined  to,  that  the 
cost  per  kilowatt  demanded  on  the  station  would  diminish  rapidly 
as  the  station  increased  in  size;  it  must  be  remembered,  however, 
that  the  above  rule  does  not  only  include  the  standing  charges  due 
to  the  central  station  alone,  but  it  includes  all  expenses  due  to 
mains,  meters,  service  lines,  etc.,  and  that  the  statement  does  not 
by  any  means  imply  that  two  stations  can  be  as  economically  run  as 
one  of  the  same  capacity  as  the  two. 

The  above  tendency  seems  capable  of  explanation  after  the 
following  considerations : — 

That  although  the  original  Basic  charges  become  less  and  less 
in  proportion  to  the  total  expenditure,  as  the  undertaking  grows 
larger,  other  charges  of  a  similar  pioneering  character  continue  to 
be  incurred  from  year  to  year;  such  for  instance,  as  those  on  account 
of  the  cost  of  extending  supply  mains  into  new  districts,  running 
or  building  from  time  to  time  expensive  feeders  and  sub-stations; 
increased  office  and  engine  house  accommodation  which  are  generally 
built  many  years  before  their  full  capacity  is  wanted,  and  moreover 
this  class  of  expenditure  is  not  generally  all  incurred  simultaneously, 
but  is  spread  over  a  great  many  years  after  the  starting  of  the  under- 
taking. Also,  as  regards  the  connection  expenses,  as  the  business 
grows  larger,  the  average  individual  demand  of  the  consumers  on 
the  station  tends  to  become  smaller  for  the  two  following  reasons : — 

No.  1. — Because  the  class  of  consumers  generally  requiring 
to  be  connected  soon  after  the  commencement  of  the  undertaking 
are  the  larger  business  premises,  shops  and  hotels,  which  do  not 
cost  for  connection  so  much  per  kilowatt  demanded  as  do  the  suc- 
ceeding classes  of  smaller  shops  and  private  houses. 


42 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


No.  2. — As  the  number  of  consumers  supplied  increases,  a 
greater  variety  of  classes  are  included  among  them,  and  the  diver- 
sity of  the  hours  at  which  they  use  their  maximum  loads  tends  to 
increase,  so  that  a  smaller  kilowatt  capacity  of  the  plant  and  mains 
is  thus  required  than  if  only  one  class,  such  as  shops,  whose  maxi- 
mum demands  would  be  more  simultaneous,  were  supplied;  this 
and  the  former  cause  both  obviously  must  tend  to  make  the  connec- 
tion cost  per  kilowatt  demanded  on  the  mains  increase  with  the 
growth  of  the  supply  undertaking. 

The  above  reasons  appear  to  the  author  quite  sufficient  to 
account  for  the  observed  near  proportionality  of  the  standing 
charges  to  the  maximum  load  on  the  mains  of  a  station  in  full 
working  order. 

Comparison  of  Calculated  Costs  and  Actual  Costs 

The  other  method  referred  to,  which  can  be  made  use  of  in 
determining  what  effect  the  varying  output  has  on  the  various  items 


ifQQ 

r„ 

rua 

?2 

/r)a  an 

reff.mfi'.ryf-  a-f 

J 

/^ 

ftciual  and  Galea laHcf  Cosf 

111 

\ 

/^OQ 

} 

/12fl 

J 

f 

/30(1 

t 
1 

\ 

\ 

/ 

/zp<^ 

\L 

^\ 

f 

(fffO 

/^OQ 

I 

fon 

/) 

MQ 

J 

^ 

Ai 

r 

?9n 

/ 

6QQ 

I 

t 

T<7ft 

f^ 

1    / 

/' 

4oo 

f<o- 

i/' 

*- 

*7r- 

3oa 

^ 

^ 

a 

Zoo 

rjoni^hly  Cdsf  Co/cafen 
^frorn  formula 

W 

/oo 

Q 

1 

1      1       i 

/693 

1694 

I89S 

COST  OF  ELECTRICITY  SUPPLY  43 

constituting  the  total  cost  of  supplying  electricity,  especially  with 
stations  that  have  been  running  for  three  or  four  years,  is  that  of 
analysing  graphically  curves  of  monthly  total  expenditure,  output 
and  maximum  demand;  although  this  is  more  tedious  and  of  more 
theoretical  than  practical  value,  the  close  agreement  between  the 
Brighton  actual  with  the  monthly  costs  calculated  from  the  empiri- 
cal formula  thus  obtained  is  another  proof  that  the  cost  per  unit  for 
running  expenses  is  not  now  more  than  .8  of  a  penny. 

The  formula  from  which  the  dotted  line  on  Fig.  2  is  calculated 
is  the  one  found  to  most  nearly  fit  the  last  three  years'  curves,  and 
is  as  follows: — 

Total  monthly  expenditure  in  £ 

Units  sold  per  month 


=  £190  +  1.^25  X  D  + 


300 


Where  D  is  the  value  in  kilowatts  on  the  gradually  increasing 
maximum  load  line  of  Fig.  1. 

From  the  near  agreement  of  the  two  analyses  of  1895  revenue 
account  of  the  Brighton  undertaking,  the  author  feels  justified  in 
assuming  that  the  cost  of  continuing  to  run  the  machinery  after  it 
is  once  in  a  position  to  supply  has  not  varied  very  much  from  ^d. 
per  unit  during  the  last  three  years,  and  that  the  annual  standing 
charges  can  now  be  taken  to  be  about  £17.9  per  annual  maximum 
kilowatt  taken  from  the  mains. 

Apportionment  of  Standing  Charges 

The  question  next  arises,  how  is  each  consumer's  proper  propor- 
tion of  the  annual  total  Standing  Charges,  as  determined  in  the 
manner  previously  described,  to  be  properly  apportioned? 

Theoretically,  it  might  be  said  that  the  standing  charges  ought 
to  be  divided  into  amounts  proportionate  to  the  maximum  demand 
of  each  consumer,  at  the  day  and  at  the  very  time  the  maximum 
load  occurred  on  the  mains  each  year.  This,  however,  it  is  obvi- 
ously impossible  to  determine  in  practice,  and  would  not  be,  more- 
over, necessarily  equitable  to  the  consumers  who  might  or  might 
not  have  used  their  maximum  demands  at  the  exact  moment  in 
question.  In  practice  some  arbitrary  definitions,  more  or  less 
equitable,  of  what  constitutes  a  consumer's  call  on  the  plant  have 
to  be  made.     At  Brighton,  for  instance,  instead  of  taking  a  con- 


44  DEVELOPMENT  OF  SCIENTIFIC  RATES 

sumer's  maximum  demand  to  be  the  greatest  rate  of  taking  current 
during  the  year,  it  has  been  considered  fairer  to  the  consumer  to 
take  the  mean  of  six  winter  months'  readings  of  a  maximum  current 
indicator,  which,  by  its  very  nature,  takes  quite  ten  minutes  to 
fully  register  the  passing  current.  For  the  purposes  of  calculating 
the  cost  of  supplying  any  individual  consumer,  it  is  then  assumed 
that  the  mean  demand  as  above  defined,  bears  to  the  total  of  all 
the  consumers'  demands,  the  same  proportion  that  the  plant  and 
mains  necessary  to  supply  this  one  consumer  bears  to  the  total 
plant,  etc.,  required  for  all  the  consumers,  therefore  a  proportion 
of  the  total  annual  standing  charges  are  debited  to  each  consumer 
in  proportion  to  his  mean  demand. 

In  the  opinion  of  the  author,  this  method  gives  as  nearly  as 
possible  the  fairest  division  of  the  standing  charges,  and  it  makes 
substantial  allowance  for  the  fact,  that  the  demands  of  the  different 
consumers  do  not  all  coincide  in  point  of  time  of  day.  Opportuni- 
ties are  also  given  for  preventing  any  unusual  maximum  demand 
being  registered,  so  as  not  to  penalise  the  consumers  for  having 
parties,  etc. 

Diversity  Factor 

Owing  to  the  varying  time  of  day  at  which  the  different  con- 
sumers' heaviest  loads  are  taken  from  the  mains  among  the  fairly 
large  and  representative  number  of  consumers  at  Brighton,  the 
maximum  load  of  the  station  is  now  only  66  per  cent,  of  the  sum 
total  of  the  consumers'  maximum  demands.  This  want  of  coinci- 
dence in  point  of  time  of  the  consumers'  maxima  thus  means  a 
considerable  saving  in  plant  and  mains,  consequently  in  the  standing 
charges  of  the  undertaking;  therefore  the  consumers  are  entitled 
to  the  benefit  of  this,  which  they  get  by  the  Corporation  assuming 
that  each  kilowatt  demanded  by  a  consumer  only  costs  QQ  per  cent, 
of  the  above  mentioned  £17.9  a  year,  or  £11.8  per  annum,  which 
works  out  to  nearly  7^d.  per  day  per  kilowatt  demanded  by  any 
consumer. 

Load  Factor — Cost  Curves 

This  figure  of  7%d.  per  kilowatt,  and  the  previously  deter- 
mined figure  of  .71d.  per  unit  for  running  expenses  enables  the 
cost  of  supplying  electricity  to  any  consumer  in  Brighton  this  year 
to  be  very  closely  ascertained,  and  from  this  data  the  curve  of 
costs,  Fig.  3,  has  been  drawn. 


COST  OF  ELECTRICITY  SUPPLY 


45 


The  solid  line  gives  the  average  cost  of  supplying  each  unit  to  a 
consumer  at  Brighton  in  1895,  who  used  his  demand  so  many  hours 
or  fractions  of  an  hour  per  day  on  the  average  throughout  the  year. 
The  hyperbolic  line  of  dashes  shows  how  rapidly  the  charge  to  cover 


^ 

! 

1 

<.f 

..  ,1 

1 

C(ji9ve  or  fJfcH^&e Cost ^CMRse^J 

/■f 

! 

_j      .      i            1            1      .      . 

A? 

/2  '1 

! 

1 

//    '' 

1 

1 

i 

1 

J 

1 

1 

j 

i 

1 

.0    \ 

! 

1 

1 

1 

9 

! 

j 

I 

i 

ff 

\ 

! 

1 

1 
1 

? 

►  A 
'  vV 

fi    ^ 

'    \\ 

\ 

'     v\ 

K 

1 

s    \ 

8,  kv 

1 

i 

< 

\     Vn 

'4 

1 

4     V 

'  i\ 

V 

"■^i^ 

! 

i 

\ 

i  i ' 

s 

s 

i 

~- 

-- 

^_ 

^s-n^/H  i 

4  f. 

rr^ 

^ 

3    0 

\ 

\ 

-^ 

'  T 

r1 

D 

V 

N 

K 

1 

~  — 

"■- 

-+- 

-_ 

^_ 

S^yyrs/^odr     ki  ifi-L     1 

V 

'v  i 

^"h 

; 

1     T 
i 

--     ... 

1 

t~ 

i 

'< 

^~^--~ 

— 

— , 

a^»^^c» 

S»*  //»y»acJ 

/ 

' 

1 

•-., 

.jc- 

^jye^ 

.    y  L        1           1 

1  ■ 

1^ 

! 

r 

"-yr- 

?a? 

'■-^ 

W|SSL 

W?. 

/ 

i 

i    v3 

1  4- 

J 

6 

7 

N  N 

''<i 

// 

^^ 

tJ^     ^-f  h,^,,m^    ^^,r,^^^  !t    ,1^^^  rJ^n.. 

^j 

V 

i_ 

the  standing  costs  falls  as  the  time  of  daily  use  of  the  demand  is 
lengthened;  the  total  cost  curve  is  obviously  obtained  from  this  by 
adding  .71  to  it  vertically. 
Differential  Rate 

As  it  was  thought  impolitic  to  charge  consumers  on  the  true 
theoretical  method  of  so  much  per  maximum  kilowatt  demanded. 


46  DEVELOPMENT  OF  SCIENTIFIC  RATES 

and  so  much  for  the  running  costs  of  the  units  registered  by  their 
meters,  on  the  ground  that  this  tariff  might  possibly  have  the  effect 
of  preventing  consumers  instalHng  any  other  lamps  than  those 
likely  to  be  constantly  used,  it  was  suggested  that  nearly  as  fair  a 
charge  could  be  made,  by  refusing  to  reduce  the  highest  permissible 
price  per  unit  consumed,  until  the  individual  consumer  had  paid  off 
all  his  proportion  of  the  year's  standing  charges,  as  determined  by 
the  demand  indicator,  in  the  manner  above  described.  This 
system  has  worked  out  very  well  during  the  last  three  and  a  half 
years,  and  naturally  tends  to  encourage  profitable  consumers  to 
use  electricity. 

From  the  above  calculations  it  follows,  provided  all  consumers 
paid  83^d.  per  unit  for  the  first  365  hours  in  the  year  they  used 
their  demand,  and  ^d.  for  all  units  consumed  afterwards  in  that 
year,  the  whole  of  the  annual  expenditure  would  be  covered,  and 
the  Brighton  undertaking  would  be  considered  in  a  self-supporting 
condition.  However,  there  will  always  be  a  considerable  number 
of  consumers  who  do  not  use  their  demand  on  the  average  one  hour 
per  day  throughout  the  year,  among  whom  of  course  must  be 
included  a  great  many  of  those  connected  during  the  year  in  ques- 
tion, and  as  the  maximum  price  chargeable  at  Brighton  is  fixed  at 
7d.  per  unit,  it  is  impossible  to  charge  on  this  equitable  basis.  The 
tariffs  adopted  for  the  last  three  years  have  been  something  there- 
fore less  fair  to  the  long  hour  profitable  consumer,  and  by  the  one 
now  in  force  each  consumer  pays  7d.  per  unit  for  the  first  365  hours 
in  each  year  he  uses  his  demand  and  3d.  afterwards.  This  tariff 
will  doubtless  produce  sufficient  profit  during  this  present  year 
from  the  units  charged  at  3d.  to  people  using  their  demand,  say 
slightly  more  than  IJ/2  hours  per  day  to  justify  a  reduction  in  the 
3d.  units  being  very  soon  made  to  2d.  per  unit. 

Short  Hour  Consumers  Not  Profitable 

The  small  dotted  curves  show  the  average  price  paid  by  the 
Brighton  consumers  on  the  present  and  proposed  future  tariffs 
according  to  the  average  daily  number  of  hours  they  individually 
use  their  demands. 

From  an  inspection  of  the  tariff  and  cost  curves  in  Fig.  3,  it 
will  be  seen  that  loss  was  incurred  in  supplying  all  consumers  at 
Brighton  during  1895  who  used  their  demands  less  than  600  hours 
per  annum.     In  connection  with  these  unprofitable  consumers,  it 


COST  OF  ELECTRICITY  SUPPLY  47 

may  be  quite  reasonably  asked  how  with  a  given  plant  and  set  of 
mains  it  can  be  said  that  the  undertaking  can  lose  money  by  having 
to  supply  one  set  of  short  time  consumers  while  it  is  making  a  profit 
on  supplying  others  with  the  same  commodity,  or  why  selling  units 
at  7d.  can  be  less  profitable  than  not  selling  them  at  all.  The 
answer  is,  that  in  growing  stations,  as  the  author  premised  should 
alone  be  considered,  the  same  expensive  extensions  and  the  conse- 
quent increase  of  standing  costs  are  necessitated  by  having  to 
supply  the  short  time  consumers  as  if  they  were  long  hour  users, 
although  they  probably  only  use  their  proportion  of  the  plant  say 
three  months  out  of  the  twelve;  thus  they  not  only  cause  fresh 
capital  to  be  spent,  the  interest,  etc.,  on  which  they  cannot  pay  off 
themselves,  but  they  necessitate  their  unpaid  share  of  the  standing 
charges  being  paid  by  the  better  class  of  consumers,  who  could  have 
been  supplied  from  the  station  in  the  condition  it  was  in  at  the  end 
of  the  year  without  further  extensions  having  to  be  made  for  many 
years  to  come;  therefore,  actually  this  short  time  class  increase  the 
charges  to  the  profitable,  and  this  is  surely  only  another  way  of 
stating  that  there  is  loss  incurred  by  having  to  supply  them. 

Profit  and  Loss  Account 

Given  the  cost  of  the  standing  charges  per  kilowatt  demanded 
by  the  consumers,  the  running  costs  per  unit  and  the  individual 
demands  of  all  the  consumers,  it  must  be  obvious  that  it  is  then 
possible  to  make  out  an  annual  Profit  and  Loss  Account  showing 
what  profit  or  loss  is  made  from  any  class  of  consumers.  The  author 
has  prepared  such  a  one  for  the  Brighton  undertaking  in  1895. 
He  has  taken  the  running  costs  at  8d.  per  unit,  and  has  divided  the 
classes  of  consumers  into  the  four  following: — 

1.  Those  who  were  connected  during  the  year,  and  of  which 
a  great  many  therefore  could  not  naturally  have  had  enough  time 
to  pay  off  their  proportion  of  the  standing  charges  incurred  during 
the  year  in  providing  sufficient  additional  plant  for  their  probable 
demands. 

2.  The  consumers  who  did  not  consume  sufficient  electricity 
to  be  equivalent  to  the  use  of  their  demand  365  hours  or  one  hour 
per  day  on  the  average. 

3.  Those  who  were  a  source  of  loss  to  the  undertaking  owing 
to  their  using  their  demand  less  than  Ij^  hours  per  day,  which 
was  about  the  minimum  time  necessary  on  the  present  tariff  to 
pay  off  all  the  cost  of  supplying  them  for  that  period. 


48 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


.    ee 

u     0; 

C3     >> 

Ms 

J=  *J   >» 

r  ^  s 

ighou 
roug] 
out  t 

•X   '^  -^ 

^ 

2  -  S? 

s; 

5  &  E 

vN 

^?^ 

a 

2   >   iu 

v 

cS   j;     S 

s 

o;    ^     > 

^      rH      :« 

<1^ 

-^     O     O 

-M 

C5     ^   -^ 

C3 

o    J-- 

C/3 

s-^g 

GO 

J 

ur  pe 
hour 
per  c 

^3 

^    ^   -C 

-w 
« 

05 

j3  ^^  I— ( 

S 

I-H 

t«  '-'  t) 

Oh 

J^  % 

3 

-:3  -0  13 

fl     C!     C 

.-«     03     c« 

-o 

s  s  s 

i^ 

ij      V      V 

o 

-^    13    -O 

0. 

c 
a 

W)  bc  bc 

fl     C     C3 

!ZI         M         t« 

o 

w 

!»        03       W 

lt< 

0)      Cj.     OJ 

E 

s  s  s 

3 

3     3     3 

a 

dec 

o 

O     o     o 

U  U  u  u 

1       !       1       1 

pH 

'      1      1 

CO 

i»     w     w 

w 

w     M     tn 

ce 

i3  J5  J5 

■CJ 

U  U  U 

.       .       •  (« 

<M 

rp 

X 

to 

...  © 

© 

«o 

00         1 

2    i 

o 

c+i   :   :   :  w 

*l 

®                   «1 

PL, 

.    .    .  co" 

co" 

O) 

ph 

1a2 

1       ^ 

*"  s  S 

01 

•*    l-H    0>         • 

;z;    2 

« 

^iss  •: 

0 

^ 

of 

^ 

«5        •  r-l   P-l 

t^ 

ly 

^§3  .-^S 

«5 

Oh 

•    ^" 

"* 

t 

V 

3 

.-1     •  :d  ^ 

X 

"^ 

a 

^^  :2^ 

OS 

^ 

4* 

> 

c 

£ 

01 

«: 

co' 

'a 

iJ 

i 

0      •  «5  0 

"S  «  o-= 

c^*     i^^. 

^ 

c-2   .  S 

«5 

=  0:2  =■ 

. 

" 

" 

0<      .  00  X 

CO 

00      .  l>  1-1 

l> 

=■  Sis 

«5      •  <^,  *l 

x^ 

•u      ■-   ^ 

0  cS^ 

»o    ■  o~  05 

MO 

•-c* 

0*        ■    r-H    «C 

OS 

0  « 

Tf. 

^ 

f<t 

05  ^  0   05 

OS 

" 

Pj  00  0^  CO  "* 

00 

3 

CO 

'-' 

co" 

i 

"-I  X  05  o< 

© 

c 

•£5  CO  0*0* 

•* 

4; 

=^    "'2^' 

X 

V 

©" 

tf 

T-i 

00s  OS  -^ 

OS 

H 

"S      * 

-  .  OS  «5  «Q  l> 

H^  rH  0  «5  80 

l> 

^ 

H      1 

0 

©f  of  r^  CO 

"* 

« 

"3 

I-H 

f^ 
g 

=  «§s^ 

0  0  OS  ^ 

^ 

P 

. 

(T^i  .-1  CO  ■*  CO 
'=+<  ^  ^  ^  X 

0* 

Z 

I-H 

< 

-0 

U    t. 

12; 

©  OS  0  0 

OS 

<3 

(vj  X  0*  ^  ■* 

^  0  OS  ^^  ^^ 

M5 

OS 

H 
2; 

of  ^  r^  l> 

of 

^ 

4=    0 

5 

0 

u 

m 

^        -O 

GO  CO  'iJh  CO 

,—1 

» 

0  0  «;  '* 

0* 

tf 

«5  0^  »o  ■* 

«5 

of  oT  wo  ■* 

I-H 

CO  00  •*  »o 

i> 

©< 

00 

"^." 

.SsSS 

10  o»  X  10 

31 1 

J>  CO  r-l  CO 

^  ,_,  ^  CO 

© 

eS    4 

l-o^ 

^ 

— 2 — 

i 

en 

cS 

.-t  0<  GO  -* 

cC 

II 

0 

1 

COST  OF  ELECTRICITY  SUPPLY  49 

4.  The  profitable  class  who  used  their  demand  more  than 
about  13^  hours  per  day  on  the  average  throughout  the  year. 

From  the  foregoing  profit  and  loss  account  it  will  be  seen  that 
in  consequence  of  the  highest  price  allowable  being  fixed  at  Brighton 
at  7d.  per  unit,  it  was  necessary  to  charge  the  longer  users  of  elec- 
tricity at  a  substantial  profit  to  recoup  the  losses  incurred  in  having 
to  supply  the  unprofitable,  although  this  was  nothing  approaching 
the  rate  of  profit  that  would  have  been  charged  to  them  had  all 
consumers  paid  the  uniform  price  per  unit  necessary  to  produce  the 
same  revenue. 

Conclusions 

The  results  of  the  above  presumably  correct  methods  of  analysis 
being  applied  to  existing  electricity  works'  accounts  appear  to  so 
thoroughly  confirm  Dr.  Hopkinson's  startling  conclusions,  and  to 
warrant  so  many  fresh  departures  from  the  usual  methods  of  at- 
tempting to  develop  the  business  of  Electricity  Supply,  that  the 
author  sincerely  trusts  the  convention  will  carefully  criticise  the 
principles  enunciated,  and  either  frankly  combat,  refute  or  accept 
the  following  far-reaching  conclusions  the  author  has  been  forced  to 
realise. 

L  It  is  the  duty  of  municipalities  to  charge  a  uniform  rate  of 
profit  on  the  cost  of  supplying  electricity  rather  than  a  uniform 
price  to  all  consumers,  and  much  more  so  in  the  case  of  electricity 
than  with  gas,  because  of  the  much  greater  percentage  standing 
charges  bear  to  the  total  cost  in^the  former  than  in  the  latter  case. 

"2.  To  charge  the  same  amount  for  the  electricity  consumed  by 
100  lamps  burning  4  hours  a  day  as  that  by  400  lamps  burning  one 
hour  per  day  is  manifestly  unjust  to  the  longer  user,  as  only  a 
quarter  of  the  plant  and  copper  are  required  to  produce  and  supply 
it  as  are  required  by  the  shorter  user. 

3.  The  practice  of  charging  profitable  and  unprofitable  con- 
sumers the  same  price  per  unit  must  necessarily  have  the  effect  of  keep- 
ing the  average  cost  and  price  higher,  consequently  the  supply  business 
smaller,  than  by  charging  a  uniform  rate  of  profit  to  all  consumers, 
because,  having  to  charge  the  profitable  consumer  in  order  to  recoup 
the  loss  incurred  in  supplying  the  unprofitable  must  tend  to  prevent 
the  former  using  it  as  liberally  as  if  he  had  not  to  pay  such  a  high  rate 
of  profit.  Therefore  electricity  can  be  produced  at  a  lower  price  on 
an  equitable  sliding  scale  of  charges  than  on  a  uniform  price. 


50  DEVELOPMENT  OF  SCIENTIFIC  RATES 

4.  The  extremely  low  price  at  which  electricity  can  be  profit- 
ably supplied  to  consumers  after  they  have  paid  off  their  proportion 
of  the  standing  charges  much  more  than  compensates  for  the  diflS- 
culty  of  understanding  a  uniform  rate  of  profit  tariff,  as  shown  by 
the  increasing  rate  of  receiving  applications  for  electricity  in  towns 
where  differential  charges  and  low  prices  to  long  users  are  in  vogue. 

5.  It  is  in  every  sense  advisable  to  retain  the  initial  charge  per 
unit  at  the  highest  permissible  figure,  and  the  charge  for  current 
after  the  standing  charges  are  paid  for  at  as  low  a  figure  as  is  com- 
patible with  making  a  safe  annual  net  profit;  as  experience  proves 
that  consumers  judge  their  electricity  accounts  solely  on  the  total 
amount,  and  those  consumers  who  are  always  charged  the  highest 
price  are  naturally  the  least  worth  having  and  the  only  ones  likely 
to  complain  of  the  equal  profit  system  of  tariff. 

6.  It  is  erroneous  to  suppose  that  by  increasing  the  size  of  the 
business  the  loss  on  supplying  the  ordinary  short  hour  user  will 
diminish  as  time  goes  on;  as  offices  and  similar  short-time  consumers 
generally  light  up  at  dusk,  an  increased  number  of  such  can  only 
aggravate  the  peakiness  of  the  load  curve,  and  cannot  therefore  re- 
duce the  standing  charges  per  kilowatt  demanded,  on  which  the 
cost  of  supplying  them  mostly  depends. 

7.  It  is  much  fairer  to  the  ratepayers  to  try  to  limit  the  supply 
to  consumers  who  are  willing  to  pay  their  share  of  the  costs  than  to 
have  to  rapidly  extend  the  supply  works  in  order  to  take  on  more 
unprofitable  as  well  as  profitable  consumers,  or,  in  other  words,  it  is 
more  justifiable  for  a  municipality  to  lose  the  unprofitable  consumers 
by  raising  the  initial  price,  and  to  take  in  their  place  more  profitable 
ones,  than  to  extend  the  works  directly  their  capacity  is  reached. 

8.  The  enormous  cost  of  getting  ready  to  supply  electricity, 
compared  to  the  cost  of  continuing  to  supply  when  ready,  can  be 
best  realised  by  remembering  that  it  costs  two  and  a  half  times  as 
much  to  supply  a  unit  to  a  consumer  who  uses  his  lights  on  the  average 
only  one  hour  per  day  as  it  does  to  another  who  uses  them  three  hours. 

9.  With  coal  at  the  price  paid  in  Brighton,  the  same  reduction 
can  be  made  in  the  average  cost  of  producing  electricity  by  so  ar- 
ranging the  tariff  as  to  improve  the  load  factor  3  per  cent  as  if  the 
coal  bill  had  been  reduced  15  per  cent.  Although  the  author  does 
not  wish  it  to  be  understood  that  he  discourages  the  attempt  to  save 
coal,  he  desires  to  point  out  that  it  is  much  more  worth  while  trying 
to  improve  the  load  factor  than  to  reduce  the  coal  bill.     Since  the 


COST  OF  ELECTRICITY  SUPPLY  51 

differential  tariff  has  been  adopted  at  Brighton,  the  load  factor  has 
improved  50  per  cent,  showing  the  improvenent  wanted  is  not  dif- 
ficult to  attain.  In  the  Midlands,  where  coal  is  half  the  price  paid 
at  Brighton,  probably  the  same  reduction  in  the  average  total  cost 
of  electricity  would  be  made  by  improving  the  load  factor  3  per  cent 
as  if  the  coal  bill  had  been  reduced  30  per  cent. 

10.  The  differences  in  the  financial  results  of  central  supply  sta- 
tions are  more  due  to  the  different  load  factors,  and  the  varying 
economy  in  standing  by  costs,  than  by  any  great  differences  in  the 
amount  of  running  costs. 

11.  The  rapid  fall  in  the  cost  of  supplying  electricity  as  the 
average  time  of  use  increases  makes  the  small  householder  a  much 
more  profitable  class  to  supply,  both  in  his  residential  and  shopping 
districts,  than  the  residences  and  shops  where  the  wealthy  dwell  and 
deal,  owing  to  the  frequent  absence  from  home  of  this  class  and  the 
early  closing  of  their  shops. 

12.  One  of  the  most  important  consequences  of  the  fact  that 
electricity  can  be  profitably  supplied  from  central  stations  to  con- 
sumers at  the  rate  of  83/2^.  per  unit  for  the  first  365  hours  in  each 
year  they  use  their  demand,  and  for  something  between  3^d.  and  Id. 
(according  to  the  price  of  coal)  for  any  electricity  consumed  after- 
wards in  the  same  year,  is  that  street  lighting  and  that  of  basements 
or  dark  buildings  lighted  all  day  long,  can  be  more  cheaply  done  by 
electricity  than  by  any  other  form  of  artificial  light,  as  in  these 
cases,  where  the  use  is  on  the  average  eleven  hours  per  day,  or  4,000 
hours  per  annum,  the  inclusive  cost  for  the  electricity  consumed  will 
not  generally  exceed  l}4d.  per  unit. 

The  fact  that  up  to  the  present  only  the  very  fringe  of  street 
lighting  has  been  touched  by  the  Electricity  Supply  undertakings 
appears  to  the  author  a  sure  sign  that  Dr.  Hopkinson's  conclusions 
have  been  hitherto  ignored  by  most  of  the  responsible  managers, 
and  to  again  direct  and  urge  them  to  give  their  closest  attention  to 
them  has  been  the  author's  object  in  writing  this  lengthy  paper. 


Equitable,  Uniform  and 
Competitive  Rates 


by 
HENRY  L.  DOHERTY 


Presented  before  the 

National  Electric  Light  Association 

May  1900 


(Reprinted  from  Proceedings  of  National  Electric  Light 
Association,  May  1900.  pp.  291-321) 


INDEX 

Page 

Introduction 55 

Discrimination  in  Rates 55 

Comparison  with  Gas  Business 56 

Cost  of  Storage  Capacity,  Gas  and  Electricity 56 

Conductors,  Gas  and  Electric 57 

Load  Curves,  Gas  and  Electricity 57 

Fixed  Charges 58 

Methods  of  Charging". 58 

Flat  Rates 59 

Uniform  Meter  Rates 59 

Meter  Rates  Based  on  Quantity  of  Consumption 60 

Meter  Rates  with  a  Minimum  Charge 61 

Meter  Rates  Based  on  Quantity  of  Time  Maximum  Capacity 

of  Installation  Is  Used 61 

Meter  Rates  Varied  by  Total  Time  Maximum  Demand  Is  Used  61 

Meter  Rates  Varying  According  to  Time  of  Day  at  Which 

Current  Is  Used 62 

Discussion  of  Above  Rate  Systems 63 

Importance  of  Proper  Rates 63 

Factors  Governing  Rate  Making 64 

Competition 65 

Competition  by  Natural  Light 65 

Competition  by  Isolated  Plants 65 

Competition  by  Gas 66 

Elements  Essential  for  Satisfactory  Rate  System 67 

Study  of  Data  from  Existing  Central  Stations 67 

"Readiness  to  Serve"  Costs 69 

Method  of  Assessing  Readiness  to  Serve  Charges 69 

Analysis  of  Costs  of  a  Central  Station 71 

Discussion  of  Readiness  to  Serve  Rate  System 75 

Conclusion 77 


Equitable,  Uniform  and  Competitive  Rates 

By  H.  L.  Doherty 
1900 

Introduction 

We  probably  all  agree  that  the  rate  question  is  of  vital  impor- 
tance to  the  development  of  central-station  work.  Of  the  several 
methods  proposed,  none  are  universally  satisfactory,  even  to  the 
managers  of  stations  similarly  situated,  and  many  of  us  are  not 
satisfied  with  any  of  them. 

The  natural  laws  governing  the  sale  and  purchase  of  electric 
current  do  not  differ  greatly  from  those  of  any  other  commercial 
business,  except  in  one  particular;  the  average  commercial  business 
is  at  Uberty  to  bargain  and  sell  with  each  consumer;  it  is  at  liberty 
to  discriminate  in  prices  or  methods. 

Discrimination  in  Rates 

Any  company  enjoying  public  grants  is  apt  to  be  considered  as 
a  quasi  public  corporation,  and  is  amenable  to  the  general  laws  of 
this  class.  Frequent  suits  have  been  brought  to  determine  the 
right  of  a  quasi  public  corporation  to  discriminate  in  rates  between 
various  customers,  and  in  almost  every  instance  the  court  has  held 
that  such  discrimination  was  illegal.  Numerous  decisions  would 
warrant  us  in  considering  the  illegality  of  discrimination  to  be  an 
established  fact.  The  whole  question,  then,  must  hinge  on  what 
constitutes  discrimination.  There  is  probably  more  legislation  in 
vogue  for  the  control  of  railroads  than  for  any  other  class  of  quasi 
public  corporations,  and  the  Interstate  Commerce  Commission  (a 
national  board  of  control)  permits  them  to  charge  different  rates 
per  ton  for  different  distances,  not  proportional  to  the  distance,  and 
also  permits  them  to  charge  different  rates  per  ton  for  the  same 
distance  for  different  commodities.  This  would  warrant  the  belief 
that  we  could  legally  discriminate  in  our  methods  of  charging  be- 
tween different  classes  of  service  and  different  clas.ses  of  consumers. 

The  right  to  bargain  with  each  customer  is  a  doubtful  advan- 
tage, and  private  business  houses  that  are  not  amenable  to  legal 
prevention  against  discrimination  have  nearly  all  abandoned  this 


56  DEVELOPMENT  OF  SCIENTIFIC  RATES 

policy  in  favor  of  a  similar  policy  that  is  forced  upon  us  legally. 
In  view  of  the  fact  that  they  deal  with  the  same  class  of  people  as 
the  customers  of  the  average  central  station,  it  is  natural  to  suppose 
that  our  eventual  policy  will  be  one  price  to  all,  regardless  of  legal 
coercion. 

Comparison  with  Gas  Business  • 

The  electric  business  was  started  as  a  competitor  to  gas.  The 
early  promoters  of  this  new  method  of  lighting  were  naturally 
inclined  to  adopt  the  same  methods  of  charging  as  then  in  vogue 
among  their  competitors.  Without  meters,  they  were  compelled 
to  use  flat  rates.  Later,  when  meters  were  procurable,  they  adopted 
the  system  used  by  the  gas  companies,  and  have  since  gradually 
awakened  to  the  fact  that  while  this  system  may  be  suitable  to 
gas  business  (which  is  questionable),  it  is  not  suitable  to  the  electric 
business.  Much  of  the  experience  gained  in  the  gas  business  is 
applicable  to  the  electric  business,  but  there  are  certain  distinctive 
features  for  which  compensation  must  be  allowed.  Gas  companies 
can  manufacture  uniformly  for  twenty-four  hours,  being  able  to 
store  their  product  cheaply  and  economically.  The  distribution 
of  gas  does  not  require  any  exact  degree  of  pressure  regulation. 
The  conductors  used  are  hollow,  and  the  cost  does  not  increase 
proportionally  to  the  increased  conductivity. 

I  give  below  some  comparative  figures,  which  I  think  forcibly 
indicate  some  of  the  differences  between  the  electric  and  gas  business, 
requiring  special  consideration: 

Cost  of  Storage  Capacity,  Gas  and  Electricity 

Gas  per  1,000  cu.  ft $50 .  00 

Gas  per  ft .05 

Electric   per  K.  W.-hour  100.00 

Gas  per  C.  P.-hour .0033^     Incandescent    gas    lamp,    15    candles 

per  ft. 

Electric  per  C.  P.-hour. .  .  10              Arc  lighting,  1  Watt  per  candle. 

Gas  per  C.  P.-hour .0166         Open  flame,  3  candles  per  ft. 

Electric  per  C.  P.  hour. .  .312           Incandescent,  3.1  Watts  per  candle. 

Gas  per  K.  W.-hour,  de- 
veloped    1 .  25              Gas  engine,  25  cu.  ft.  per  K.  W.-hour. 

Electric  per  K.  W.-hour, 

developed 125.00              Electric  motor,  80  per  cent  eflSciency. 

Gas    per    $1.00    unit    of 

value 50.00  $1.00  per  1,000  cubic  ft. 

Electric  per  $1.00  unit  of 

value 1,000.00  .  10  per  K.  W.-hour. 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     57 


Gas  per  million  B.  T.  U.         76.97  650  B.  T.  U.  per  ft. 

Electric    per    million    B.  /778  ft.-Ibs.  per  B.  T.  U. 

T.  U 29,312.53  13,411.51  B.  T.  U.  per  K.  W.-hour. 

Gas — EflSciency  (approx- 
imately)         100  per  cent. 

Electric — Efficiency   (ap- 
proximately)    56  to  72  per  cent. 

Conductors,  Gas  and  Electric 

Gas — Size  of  pipe  (cast-iron) 2  in.     4  in.     8  in,      16  in.  30  in.        60  in. 

Area — in  circular  inches 4 

Conductivity 1 

Relative    conductivity    per    circular 

inch 1 

Relative     conductivity     of     electric 

conductors 1 

Weight  of  pipe  per  foot 6 

Relative  conductivity  per  pound.  .  1 
Relative     conductivity     of     electric 

conductors 1        1  1  1  1  1 

Load  Curves,  Gas  and  Electricity 

I  also  give  daily  and  yearly  load  curve  for  the  same  city  for  gas 
and  electric  service,  showing  also  the  percentage  "sendout"  com- 
pared with  the  generating  capacity  of  the  two  plants: 


16 
5.65 

64 
32 

256    900 
180    880 

3,600 
4,950 

1.4 

2 

2.75   3.9 

5.5 

1 

17 

2 

1 
40 
4. 

8 

1      1 
100    250 
10.4   21.2 

I 
900 
33.5 

(^(/      4<^f      ■Se^f     OcF      7io7~~Dec      Jan.        /%A      r^r      ^pr.       /jay   June 


58  DEVELOPMENT  OF  SCIENTIFIC  RATES 

Fixed  Charges 

The  central-station  business  is  one  composed  largely  of  fixed 
charges,  whose  aggregate  amount  is  not  appreciably  affected  by 
the  quantity  of  current  sold.  The  cost  of  current  delivered  on  the 
consumers'  premises  is  more  greatly  influenced  by  a  high  kilowatt 
consumption  compared  with  the  maximum  demanded  than  by  any 
other  factor  affecting  our  cost. 

Methods  of  Charging 

Tiresome  as  it  may  seem,  I  shall  have  to  consider  the  better 
known  systems  of  charging  before  proceeding  further  with  my 
argument.  I  shall  confine  this  discussion  to  the  several  distinctive 
methods  of  charging  now  in  vogue,  and  shall  not  attempt  to  discuss 
the  numerous  variations  that  have  been  injected  into  them  to  com- 
pensate for  their  lack  of  ability  to  meet  the  objections  of  the  man- 
agers adopting  them. 

The  main  distinctive  systems  are  as  follows: 

First — Flat  rates. 

Second — Uniform  meter  rates. 

Third — Meter  rates  differing  on  quantity  of  consumption. 

Fourth — Meter  rates  with  a  minimum  guarantee. 

Fifth — Meter  rates  different  on  amount  of  time  maximum  capacity  of  in- 
stallation is  used. 

Example:  New  York  system. 

Six — Meter  rates  varied  by  the  amount  of  time  maximum  demand  is  used. 

Example:  Wright  demand  system. 

Seventh — Meter  rates  varying  according  to  time  of  day  at  which  current  is 
used. 

Example:  General  Electric  Company  two- rate  meter. 

The  first  four  of  these  systems  do. not,  I  think,  have  a  single 
prominent  advocate.  The  New  York  system  is  only  mildly  advo- 
cated by  the  users,  and  they  admit  that  it  is  inequitable.  The  two 
latter  systems  are  advocated  by  some  of  the  most  prominent  men 
in  the  profession,  but  their  most  sincere  advocates  are  those  inter- 
ested in  the  patents  on  the  appliances  which  their  use  demands. 
I  say  this  without  any  wish  to  cast  reflection  upon  the  advocates 
of  these  systems.  If  any  of  us  think  a  thing  is  good  enough  to  buy, 
we  should  certainly  think  it  good  enough  to  advocate,  and  we 
should  be  entirely  justified  in  doing  so;  but  when  we,  as  central 
station  men,  consider  any  of  the  problems  in  our  business,  we 
naturally  feel  that  a  financial  interest  in  any  one  system  is  apt  to 
warp  the  judgment  of  the  one  so  interested. 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES      59 

Flat  Rates 

Objections 

First — They  are  not  suited  to  all  classes  of  consumers. 

Example  A — The  long-hour  consumer  pays  less  than  cost. 

Example  B — The  short  hour  consumer  cannot  patronize  a  station  of  this 
method  of  charging,  as  the  cost  is  apt  to  exceed  that  of  other  means  of  lighting. 

Example  C — The  cost  to  the  consumer  with  a  big  installation  and  a  small 
maximum  demand  is  prohibitive. 

Second — Rigid  inspection  is  required. 

Example  A — Fraud  is  possible  by  increasing  the  number  of  lights,  by  in- 
creasing wattage  of  the  lamps  used,  and  by  the  theft  of  current  for  other  uses. 

Third — The  installation  is  curtailed. 

Arguments  in  Favor 

First — If  the  rate  is  high  enough,  no  loss  can  occur  to  the  station  except  by 
fraud. 

Second — The  system  permits  of  simple  office  records,  and  offers  little  oppor- 
tunity for  disputes  between  company  and  consumer. 

Third — The  income  is  constant,  and  can  be  safely  anticipated. 

Fourth — The  fixed  charges  of  the  plant  are  insured. 

Fifth — They  require  no  investment  for  meters. 

Sixth — They  permit  of  accurate  calculations  of  the  distributingsyst^m. 

Seventh — Their  legality  is  not  apt  to  be  questioned. 

Uniform  Meter  Rates 

Objections 

First — They  are  not  suited  to  all  consumers. 

Example  A — The  short-hour  consumer  very  probably  does  not  pay  the 
cost  he  occasions. 

Example  B — The  long-hour  consumer  can  often  procure  other  service  more 
cheaply. 

Second — The  rapidity  with  which  bills  increase  in  the  fall  gives  rise  to  dis- 
satisfaction among  consumers,  which  is  a  menace  to  the  safety  of  central-station 
investments. 

Third — They  are  the  greatest  encouragement  to  the  installation  of  isolated 
plants,  owing  to  the  fact  that  the  long-hour  consumer  can  manufacture  his  own 
current  the  most  cheaply,  and  it  is  from  this  class  of  consumers  that  the  maxi- 
mum profit  is  demanded  by  this  system. 

Fourth — As  the  central  station  must  carry  some  consumers  at  a  loss,  they 
cannot  sell  to  profitable  consumers  at  a  price  permitting  competition  with  isolated 
plants  and  other  means  of  obtaining  light. 

Fifth — They  encourage  heavy  peaks  and  discourage  liberal  use  of  current  for 
lighting  and  other  purposes. 

Sixth — They  require  constant  arbitrary  adjustment  of  rates. 

The  second  reason  given  is,  I  think,  of  more  importance  than 
is  generally  recognized. 


60 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


I  append  chart,  showing  the  number  of  burning  hours  in  each 
month  in  the  year,  and  a  careful  study  of  this  tabulation  shows  a 
remarkable  increase  in  light  bills  in  approaching  the  season  of  least 
natural  light: 

Table  Showing  Number  of  Hours  Artificial  Light 
is  Needed  in  Each  Month  of  the  Year 


Evening  from 

"a 

3 
< 

a 

1 

o 

a 
1 

2 

a 

Q 

3 
S 

>> 

a 

3 

a 
< 

^ 

S 

s 

"3 
1 

Dusk  to  6  o'clock.  . 

2 

22 

52 

82 

112 

142 

172 

345 

48 
18 

33 
62 
93 
124 
155 
186 
217 
421 

80 
49 
18 

62 
92 
122 
152 
182 
212 
242 
473 

110 
80 
50 
20 

80 
111 
142 
173 
204 
235 
266 
527 

137 

106 

75 

44 

65 
96 
127 
158 
189 
220 
251 
512 

137 

106 

75 

44 

33 
61 
89 
117 
145 
173 
201 
411 

93 
70 
42 
14 

4 

31 

62 

93 

124 

155 

186 

382 

71 

40 

9 

279 

Dusk  to  7  o'clock .  . 

is 

44 

75 

116 

217 

14 
40 
71 
102 
133 
164 
307 

16 

4 

28 

58 

88 

118 

148 

295 

28 
3 

493 

Dusk  to  8  o'clock.  . 
Dusk  to  9  o'clock.  . 
Dusk  to  10  o'clock. 
Dusk  to  11  o'clock. 
Dusk  to  12  o'clock. 
All  niffht      .  .  .  . 

4 

29 

60 

91 

122 

242 

2 

8 

38 

68 

98 

195 

759 
1,078 
1,443 

1,808 
2,183 
4,327 

Morning  from 

4  o'clock  to  dawn .  . 

5  o'clock  to  dawn 

722 

472 

6  o'clock  to  dawn 

269 

7  o'clock  to  dawn 

122 

1 

Arguments  in  Favor 

First — Next  to  flat  rates  they  require  the  least  investment  for  measuring  ap- 
paratus, and  a  more  simple  system  of  office  records  than  the  two-rate  system. 

Second — Less  attention  is  required  than  for  any  of  the  two-rate  systems. 

Third — The  legality  of  this  system  is  not  apt  to  be  questioned. 

Meter  Rates  Based  on  Quantity  of  Consumption 

Objections 

First — They  do  not  properly  discriminate  between  customers  of  unequal 
worth. 

Second — A  lesser  consumption  often  costs  more  than  a  slightly  greater  con- 
sumption. 

Third — Their  legality  is  questionable. 

Fourth — In  addition  to  these  objections,  they  have  all  the  objections  of  the 
uniform  meter  rate  system,  except  perhaps  in  a  slighter  degree. 

Yiith. — TJiey  are  generally  based  on  nothing  accurate,  and  represent  only  the 
whim  of  the  maker. 

Arguments  in  Favor 

First — They  require  less  frequent  arbitrary  reductions  in  rate  than  the  uni- 
form meter  rate  system. 

Second — Less  attention  is  required  than  for  any  of  the  two-rate  systems. 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     61 

Meter  Rates  with  a  Minimum  Charge 

Objections 

First — The  minimum  charge  is  generally  based  on  illegal  grounds,  and  does 
not  represent  minimum  cost  to  station  for  "readiness  to  serve." 

Second — They  do  not  properly  discriminate  between  consumers  of  unequal 
worth. 

Arguments  in  Favor 

First — The  company  is  partially  or  wholly  insured  against  loss  on  short-hour 
consumers. 

Second — Insurance  against  loss  permits  them  to  sell  to  their  profitable  con- 
sumers at  a  more  equitable  rate. 

Meter  Rates  Based  on  Quantity  of  Time  Maximum  Capacity 
of  Installation  Is  Used 

This  is  what  I  term  the  New  York  system,  and  is  one  where  the 
consumer  pays  at  a  high  rate  for  the  first  one,  two  or  three  hours' 
use  of  his  total  capacity,  all  additional  current  being  given  him  at  a 
much  lower  rate. 

Objections 

First — They  are  not  suited  to  all  classes  of  consumers. 

Example  A — The  short-hour  consumer  pays  less  than  the  cost  of  service. 

Example  B — They  unjustly  discriminate  against  the  consumer  with  a  large 
installation  and  a  small  demand. 

Example  C — The  short-hour  consumers  pay  the  same  rate  per  kilowatt  until 
they  reach  a  certain  consumption,  and  yet  it  is  axiomatic  that  the  consumer  that 
uses  current  for  nearly  all  of  the  required  time  is  much  more  valuable  than  the 
consumer  that  uses  current  for  only  a  small  portion  of  the  time. 

Second — Frequent  and  ligid  inspection  is  required. 

Third — Fraud  is  encouraged. 

Fourth — A  liberal  installation  is  discouraged. 

Fifth — The  necessity  for  arbitrary  reductions  in  rates  is  not  entirely  elimi- 
nated. 

Sixth — The  legality  is  questionable. 

Arguments  in  Favor 

First — They  encourage  longer-hour  consumption  of  the  long-hour  consumers- 
Second — They  require  a  less  investment  for  measuring  apparatus  than  any 

other  two-rate  system. 

Third — Less  attention  is  required  than  for  the  two-rate  or  Wright  demand 

system. 

Meter  Rates  Varied  by  Total  Time  Maximum  Demand  Is  Used 

Or  what  is  generally  known  as  Wright  demand  system. 

Objections 

First — It  is  not  suited  to  all  classes  of  consumers. 

Example  A — Short-hour  consumers  do  not  pay  full  cost  of  service. 


62  DEVELOPMENT  OF  SCIENTIFIC  RATES 

Example  B — Long-hour  consumers  must  be.  made  to  pay  more  than  cost  of 
service  and  proportional  amount  of  profit  to  compensate  for  loss  on  short-hour 
consumers. 

Second — A  liberal  installation  is  apt  to  be  discouraged. 

Third — Liberal  consumption  is  also  apt  to  be  discouraged  for  the  sake  of 
keeping  down  maximum  demand. 

Fourth — Consumption  is  curtailed  to  lower  demand  registrations  at  seasons 
when  peak  is  not  undesirable. 

Fifth — This  system  is  apt  to  occasion  the  greatest  possible  fluctuation  of 
peaks  for  different  months  in  the  year,  while  a  uniform  peak  is  desirable. 

Sixth — The  charge  bears  no  exact  relationship  to  the  cost. 

Seventh — Errors  in  reading  cannot  be  rectified. 

Eighth — Accuracy  of  readings  cannot  be  demonstrated. 

Ninth — The  equipment  is  expensive. 

Tenth — It  is  the  most  complicated  of  all  two-rate  systems  and  is  the  least 
apt  to  be  fully  understood  by  the  consumer,  and,  therefore,  not  apt  to  inspire  the 
consumer  with  confidence. 

Eleventh — Cost  of  inspection  is  increased. 

Twelfth — It  is  possible  for  the  company  to  be  defrauded  by  collusion  be- 
tween the  inspector  and  the  consumer. 

Thirteenth — It  does  not  eliminate  the  necessity  for  arbitrary  reduction  in 
rates. 

Fourteenth — Its   legality   is    questionable. 

Arguments  in  Favor 

First — In  general  the  charge  to  the  consumer  more  closely  approaches  the 
cost  he  occasions  than  any  of  the  other  systems  enumerated. 

Second — It  permits  concessions  to  valuable  consumers  with  some  degree  of 
accuracy. 

Meter  Rates  Varying  According  to  Time  of  Day  at  Which  Current  Is  Used 

Example — General   Electric    Company's   two-rate   meter. 
Objections 

First — It  is  not  suited  to  all  consumers. 

Example  A — A  short-hour  consumer  does  not  pay  as  much  as  the  service  costs. 

Example  B — It  discourages  the  use  of  light  at  a  time  when  such  use  is  de- 
sirable. 

Second — It  is  apt  to  inspire  but  little  confidence  in  the  consumer. 

Third — It  is  expensive  to  buy  and  to  maintain. 

Fourth — It  charges  the  most  for  current  at  a  time  when  the  cost  is  least. 

Fifth — It  does  not  properly  discriminate  between  short-hour  and  long-hour 
consumption. 

Sixth — It  requires  frequent  settings  for  different  periods  of  the  year. 

Seventh — Its  legality  is  questionable. 

Arguments  in  Favor 

First — It  encourages  consumption  at  some  of  the  desirable  hours. 

Second — Errors  in  reading  can  be  rectified  and  their  accuracy  demonstrated 
to  the  consumer. 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     63 

Discussion  of  Above  Rate  Systems 

None  of  these  systems  will  show  any  exact  relationship  between 
the  cost  to  the  central  station  and  the  charge  to  the  consumer. 
Charging  on  basis  of  maximum  capacity  installed  is  so  inequitable, 
that  I  hardly  feel  called  upon  to  defend  my  objections  to  it. 

The  Wright  demand  system  has  certainly  proved  a  step  in  the 
right  direction,  but  the  fact  that  of  even  its  warmest  advocates  no 
two  agree  exactly  as  to  how  it  should  be  used,  seems  almost  conclu- 
sive evidence  that  it  is  not  by  any  means  perfect. 

The  two-rate  meter  is  also  an  important  change  from  former 
methods,  but  it  is  almost  ridiculous  to  sell  current  at  a  lesser  price 
when  it  costs  us  most  and  at  a  greater  price  when  it  costs  us  least. 
Assuming  that  commercial  expediency  warrants  this  peculiar  condi- 
tion, there  are  other  and  more  serious  objections  which  limit  its  use 
to  special  cases. 

Importance  of  Proper  Rates 

During  the  past  two  years  I  have  made  a  careful  physical  and 
financial  examination  of  twelve  stations,  in  cities  varying  in  size 
from  1 '2,000  to  250,000  population;  during  the  same  period  I  have 
made  a  similar  but  less  thorough  examination  of  eight  central  sta- 
tions, in  cities  varying  in  size  from  4,000  to  600,000.  In  every  case  it 
seemed  to  me  that  a  good  system  of  rates  was  more  badly  needed 
than  anything  else.  None  of  the  stations  had  uniform  rates;  four 
of  them  had  more  than  fifty  per  cent  of  their  consumers  on  special 
rates.  None  of  the  systems  outlined  above  were  universally 
applicable  to  all  the  central  stations  examined. 

Paradoxical  as  it  may  seem,  the  stations  realizing  the  lowest 
income  per  kilowatt-hour  were  generally  making  the  largest  return 
on  their  total  investment.  As  all  of  these  stations  •  showed  the 
greatest  kilowatt  output  compared  with  their  total  generating  ca- 
pacity, I  have  concluded  that  their  increased  earnings  were  entirely 
due  to  a  greater  use  of  light,  which  is  very  apt  to  follow  the  intro- 
duction of  low  rates. 

In  addition  to  the  exainination  of  other  stations,  I  have  had 
occasion  to  fix  rates  for  three  central  stations  during  the  past  year. 
Of  the  many  trying  problems  that  are  apt  to  confront  a  central- 
station  manager,  I  am  free  to  confess  that  I  felt  less  ability  to  deal 
with  the  rate  question  than  with  any  other  that  might  have  come 
up.     I  have  tried  to  study  the  rate  question,  simply  to  be  able  to 


64  DEVELOPMENT  OF  SCIENTIFIC  RATES 

act  intelligently  when  again  forced  to  decide  on  the  rearrangement 
of  rates  for  an  existing  central  station  or  on  the  arrangement  of 
rates  for  a  new  central  station. 

Factors  Governing  Rate  Making 

From  a  commercial  standpoint,  we  are  governed  by  two  general 
laws: 

First — We  must  not  sell  at  less  than  cost  to  us. 

Second — -We  must  sell  at  no  greater  cost  to  the  consumer  that  that  at  which 
the  same  service  or  a  suitable  substitute  can  be  obtained  by  other  means. 

This  gives  us  certain  limitations  upon  which  to  base  our  methods 
of  charging. 

First — Our  minimum  must  be  not  less  than  the  cost  to  us;  and 

Second — Our  maximum  must  be  not  greater  than  the  worth  to  the  consumer. 

Other  factors  that  may  be  considered  are  these: 

First — If  we  must  provide  for  a  heavy  peak  for  one  month  or  one  night  in  the 
year,  it  is  desirable  to  have  as  nearly  as  possible  the  same  demand  throughout  the 
year  (assuming,  of  course,  the  same  characteristic  load  curve),  and  any  system 
tending  to  depress  this  peak  at  other  seasons  than  our  maximum  load,  is  unwise 
and  objectionable. 

Second — Any  system  that  tends  to  depress  this  curve  at  any  other  point  than 
the  peak,  is  unwise  and  objectionable. 

Third — If  we  lose  on  one  customer,  we  must  make  it  up  on  another  customer. 

Fourth — If  we  lose  on  some  customers,  we  cannot  sell  so  cheaply  to  others, 
and  are  at  a  disadvantage  when  sharp  competition  is  met. 

Fifth — If  we  lose  on  one  consumer  for  a  portion  of  a  year,  we  cannot  realize 
the  same  yearly  profit  without  charging  a  correspondingly  higher  profit  for  the 
rest  of  the  year. 

Sixth — There  are  certain  short-hour  consumers  that  are  a  loss  to  the  central 
stations'  operation  at  even  twenty  cents  per  kilowatt-hour. 

Seventh— The  variations  in  cost  of  lighting  to  the  consumer  during  different 
seasons  of  the  year  should  not  be  greater  than  the  variations  in  cost  to  us. 

Eighth — Legal  restrictions  in  central-station  operations  will  increase  rather 
than  diminish. 

Ninth — It  is  desirable  that  our  methods  of  charging  should  permit  of  favor- 
able comparison  with  other  means  of  illumination,  and  especially  with  isolated 
plants. 

Tenth — Under  an  ordinary  meter-rate  system  a  consumer  that  has  two  means 
of  illumination  is  apt  to  use  electricity  for  short-hour  consumption  and  other 
means  for  long-hour  consumption. 

Eleventh — We  are  more  interested  in  knowing  what  our  consumers'  maximum 
demand  is  going  to  be  than  in  knowing  what  it  has  been. 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     65 

Competition 

As  one  of  the  chief  factors  in  determining  the  proper  methods  of 
charging  is  to  meet  competition,  a  short  consideration  of  this  sub- 
ject is  not  out  of  place.  It  is  probably  necessary  to  consider  only 
the  sources  of  competition  named  below. 

I  give  the  first  three  of  them  in  the  order  that  I  consider  to  be 
their  future  importance: 

First — Natural  light. 
Second — Isolated  plants. 
Third — Mineral  oil. 
Fourth — Gas. 

I  do  not  attempt  to  place  gas  in  any  order  of  importance,  as  its 
future  for  lighting  is  largely  problematic,  and  should  I  give  the 
possibilities  that  I  see  for  this  agent,  it  might  lead  the  discussion 
from  the  real  merits  of  the  subject  of  my  paper.  I  will  consider  it 
only  in  the  sense  of  its  present  development. 

Competition  by  Natural  Light 

The  competition  from  natural  light  is  seldom  considered,  in 
spite  of  the  fact  that  in  many  instances  artificial  light  is  cheaper 
and  more  satisfactory  than  natural  light.  The  most  frantic  efforts 
in  architecture  are  often  made  to  obtain  natural  light  and  ventilation, 
frequently  at  the  sacrifice  of  room  and  economy  in  building.  I 
believe  many  of  our  modern  buildings  could  be  artificially  lighted 
and  ventilated  at  less  cost  than  the  sacrifice  of  room  often  requires. 
Natural  light  is  not  always  to  be  preferred  to  artificial  light.  I  have 
often  closed  my  shade  while  in  my  office  in  New  York,  and  have 
resorted  to  artificial  light  in  preference  to  the  reflected  light  from 
the  glazed  wall  on  the  opposite  side  of  the  court,  which  is  at  times 
extremely  irregular,  owing  to  the  sun  being  momentarily  obscured 
by  clouds. 

The  primary  reason  for  architecture  that  yields  artificial  light 
is  often  an  effort  for  ventilation,  which  can  always  be  more  satis- 
factorily furnished  bj'  artificial  means.  The  manager  of  a  large 
industrial  plant  told  me  that  to  his  surprise  the  cost  of  production 
had  been  materially  lessened  by  working  the  factory  double  time. 
The  cost  of  artificial  light  had  proved  to  be  considerably  less  than 
expected  and  very  much  less  than  other  savings  effected. 

Competition  by  Isolated  Plants 

Isolated  plants  have  proved  active  competitors  and  a  thorn  in 
the  flesh  for  more  reasons  than  one.     Of  all  forms  of  competition  I 


66  DEVELOPMENT  OF  SCIENTIFIC  RATES 

like  this  one  least.  Bad  methods  of  charging  have  cultivated  the 
isolated  plant  to  an  appalling  extent.  Inability  accurately  to  deter- 
mine cost  of  service,  backed  by  threats  of  isolated  plants  from  con- 
sumers, has  cost  the  central  stations  of  the  country  thousands  of 
dollars.  An  isolated  plant  generally  robs  the  station,  not  only  of 
a  large  consumer,  but  of  a  long-hour  customer,  and  hence  a  profitable 
one. 

In  reported  costs  of  current  from  isolated  plants,  nothing  is  ever 
allowed  for  interest,  depreciation  and  ground  rent,  and  seldom  is 
anything  allowed  for  repairs,  risk  and  wages.  The  installation  of 
isolated  plants  can  generally  be  forestalled,  but  competition  from 
oil  and  gas  cannot  be  entirely  eliminated.  Many  buildings  have 
boilers  already  installed  for  heating,  and  they  feel  that  the  cost  of 
operating  a  dymano  will  not  be  much  greater.  They  sometimes 
forget  that  heat  is  wanted  but  a  few  months  in  the  year,  and  is 
objectionable  for  the  rest  of  the  year;  that  in  the  heating  season 
heat  is  wanted  most  in  the  morning  when  no  light  is  wanted,  and 
least  in  the  evening  when  most  light  is  wanted. 

Competition  from  isolated  plants  requires  the  central  stations, 
most  careful  consideration.  The  installation  of  one  isolated  plant 
is  apt  to  encourage  the  installation  of  others,  and  isolated  plants 
often  grow  into  competing  central  stations,  and  in  making  new  plans 
for  methods  of  charging  we  should  consider  competition  from  isolated 
plants  more  than  from  gas  and  oil. 

There  are  certain  classes  of  short-hour  consumers  that  the  cen- 
tral station  cannot  possibly  hope  to  supply  at  a  profit.  If  supplied 
at  a  loss,  other  customers  must  pay  this. 

Competition  by  Gas 

Aggressive  competition  with  gas  is  apt  only  to  precipitate  an 
active  war  which  will  be  harmful  to  both  companies.  Those  who 
use  electricity  under  ordinary  methods  of  charging  and  also  use  oil 
or  gas,  generally  use  the  electricity  for  intermittent  and  short-hour 
use  and  the  other  means  for  constant  and  long-hour  use. 

A  method  of  charging  which  will  reverse  this  order  is  what  is 
wanted.  Better  let  the  gas  company  supply  the  consumer  you 
cannot  supply  profitably,  and  aim  to  get  in  return  a  long-hour  con- 
sumer that  you  can  supply  profitably. 

Acetylene  gas  has  been  given  no  attention,  although  it  may 
demand  careful  consideration  later.     It  was  demonstrated  six  years 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     67 

ago  that  acetylene  could  be  marketed  at  a  competitive  price  with 
gas  and  electricity,  but  up  to  date  there  seems  to  have  been  more 
attention  paid  to  the  marketing  of  the  stock  and  bonds  than  to  the 
commodity. 

Elements  Essential  for  Satisfactory  Rate  System 

The  details  of  any  satisfactory  rate  system  must 

First — Prevent  fraud. 

Second — Not  unnecessarily  complicate  oflSce  records. 
Third — Be  easily  understood  by  the  consumer. 

Fourth — Be  competent  without  objectionable  inspections,  which  reflect  on 
the  honesty  of  the  consumer. 

Fifth — Encourage  a  liberal  use  of  current  compared  with  maximum  demand. 
Sixth — Inspire  the  confidence  of  the  consumer  in  its  accuracy. 

If  it  calls  for  any  special  measuring  or  recording  instruments 
they  must  meet  the  following  conditions : 

First — They  must  be  inexpensive  to  purchase  and  install. 

Second — They  must  be  durable  and  reliable. 

Third — They  must  require  minimum  attention. 

Fourth — Chances  for  errors  should  be  as  little  as  possible,  and  errors  in  their 
action  or  reading  should  be  capable  of  correction,  with  ability  to  demon.strate  this 
to  the  consumer. 

Study  of  Data  from  Existing  Central  Stations 

Owing  to  lack  of  time,  I  have  read  comparatively  little  of  the 
literature  on  the  rate  question.  To  avoid  repetition,  which  unneces- 
sarily consumes  the  time  of  a  convention  like  this,  it  is  highly  im- 
portant that  all  published  literature  on  any  particular  subject 
should  be  thoroughly  read  before  attempting  to  add  to  it.  I  have 
been  the  victim  of  circumstances  in  gathering  data  on  which  to  base 
my  arguments.  I  intended  to  take  the  average  results  of  many 
plants  to  determine  cost  of  installation  and  operating  expenses,  but 
the  reports  showed  such  a  marked  variation  that  they  could  not  be 
intelligently  used  without  further  investigation.  I  obtained  prac- 
tically no  information  that  could  be  intelligently  used  in  a  paper  of 
this  sort.  I  did,  however,  obtain  much  information  that  proved 
interesting  to  me,  and  information  that  I  think  will  also  interest 
others.  In  general,  the  cost  of  the  plants  appeared  to  range  between 
$^00  and  $400  per  kilowatt  capacity,  sometimes  going  to  $1,000 
per  kilowatt  capacity.  The  percentage  demand  per  connected  load 
seemed  'to  vary  from  twenty-eight  per  cent  to  eighty  per  cent.  A 
fair  estimate  would  seem  to  be  about  thirty-five  per  cent  on  meter 


68  DEVELOPMENT  OF  SCIENTIFIC  RATES 

basis  and  seventy-five  per  cent  on  flat-rate  basis.  Consumption 
per  lamp  per  year  seemed  to  be  very  largely  influenced  by  local 
conditions  and  the  cost  of  current.  It  is  reasonable  to  suppose  that 
the  average  consumer  increases  or  curtails  his  consumption  more 
from  a  financial  standpoint  than  from  a  standard  of  light.  He  fixes 
his  mind  on  the  sum  he  is  willing  to  pay,  and  if  his  bills  exceed  this 
amount,  he  decreases  his  consumption. 

Of  the  central  stations  reporting  the  higher  the  cost  of  current 
the  shorter  the  use  of  the  connected  load,  reports  varied  from  10,646 
watts  per  year  per  lamp  wired  up  to  a  figure  incredibly  high  as  com- 
pared with  plants  that  have  come  under  my  immediate  supervision. 
From  eighteen  to  twenty-five  kilowatt-hours  per  year  per  lamp 
wired  up  can  be  taken  as  a  fair  average  for  western  cities.  Com- 
pared with  population,  lamps  wired  up  varied  from  one  and  one- 
half  lamps  per  capita  to  one-fifth  of  one  lamp  per  capita.  Income 
per  capita  varied  from  fifty  cents  to  $3.50  per  capita.  Income 
compared  with  investment  varied  from  ten  per  cent  to  forty  per 
cent.  Difference  between  station  output  and  current  sold  was  sel- 
dom attainable,  and  plants  reporting  on  this  point  generally  showed 
losses  that  would  cause  a  gas  manager  to  have  violent  spasms. 
One  alternating-current  station  reports  an  all-year  efficiency  of 
lines,  meters  and  transformers  of  over  seventy  per  cent,  and  a 
monthly  efficiency  for  December  and  January  of  over  eighth'  per 
cent.  Only  one  station  separates  difference  between  station  meter 
registration  and  consumers'  registration  into  "accountable"  and 
"unaccountable  loss."  From  the  gross  difference  they  subtract 
transformer  iron  loss  and  meter  shunt  loss,  and  the  difference  is 
termed  by  them  "unaccounted  for,"  and  is  represented  by  their 
C^R  loss,  faulty  registration  of  meters,  theft  of  current,  and  general 
sources  of  "unaccounted  for." 

In  the  reported  costs  of  operation,  some  other  interesting  figures 
were  noted.  In  general,  the  extreme  variations  could  only  be  ex-^ 
plained  by  different  methods  of  accounting.  Abundant  evidence 
was  to  be  had  that  the  central-station  business  of  the  country  is 
seriously  in  need  of  good  and  uniform  accounting.  In  every 
instance  the  cost  for  boiler  fuel  was  such  a  small  portion  of  total 
expense  as  to  lead  me  to  believe  that  we  have  heretofore  given  this 
expense  undue  consideration.  Cost  of  lamp  renewals  in  different 
stations  varied  as  much  as  the  lengths  of  different  pieces  of  string. 
Some  stations  reported  cost  of  lamp  renewals  at  almost  a  negligible 
figure.     Two  stations  reported  cost  of  lamp  renewals  at  approxi- 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     69 

mately  the  cost  of  boiler  fuel.  Assuming  cost  of  lamps  at  eighteen 
cents  each  and  a  life  of  600  hours,  the  expense  is  six-tenths  of  a  cent 
per  kilowatt-hour.  This  would  be  equivalent  to  cost  of  boiler  fuel 
if  six  pounds  of  coal  costing  two  dollars  per  ton  were  used  per  kilo- 
watt-hour generated.  The  importance  of  this  item  of  expense 
seldom  seemed  to  appeal  to  the  central-station  manager,  as  the  cost 
where  shown  on  a  kilowatt  basis  was  generally  figured  on  total 
output  of  station,  which  included  current  sold  for  power  and  arc 
lighting.  One  station  has  a  much  larger  output  in  kilowatt-hours 
for  power  purposes  than  for  incandescent  lighting,  and  yet  has  but 
one-fourth  of  the  generating  capacity,  both  being  taxed  at  their  peak 
to  the  utmost. 

"Readiness  to  Serve"  Costs 

The  basic  reason  for  meter  rates  based  on  quantity  of  consump- 
tion is  the  mistaken  idea  that  the  larger  the  consumption,  the  less 
the  cost  to  the  station.  The  basic  reason  for  the  New  York  and 
Wright  demand  system  is  the  idea  that  the  larger  the  consumption, 
the  less  is  the  corresponding  cost  to  serve.  A  certain  expense  is 
incurred  for  *'readiness  to  serve"  and  an  increased  consumption  does 
not  occasion  a  corresponding  increase  in  expenses.  Now,  if  our  cost 
is  on  this  basis,  and  we  want  a  system  of  charging  that  will  corre- 
spond to  the  cost,  why  should  we  not  make  our  rates  on  this  same 
basis  .^  Why  should  we  not  charge  them  at  least  our  cost  for  readi- 
ness to  serve  .^ 

Our  expenses  for  "readiness  to  serve"  are  fixed  by: 

First — The  number  of  consumers. 

Second — The  number  of  meters. 

Third — The  maximum  current  demanded. 

If  our  cost  is  the  result  of  these  factors,  why  should  we  not  base 
our  charges  on  them.^  This  seems  to  me  the  most  natural  and  logi- 
cal course.  It  corresponds  to  the  cost  for  service  from  isolated 
plants,  for  such  an  installation  occasions: 

First — A  certain  cost  for  each  plant,  regardless  of  size. 

Second — An  additional  cost,  based  on  capacity  demanded. 

Third — An  additional  cost  per  kilowatt-hour  generated. 

Method  of  Assessing  Readiness  to  Serve  Charges 

If  we  are  going  to  make  a  consumer  pay  for  readiness  to  serve  his 
maximum  demand,  how  shall  it  be  fixed  or  determined.^  Should  a 
consumer  pay  for  his  maximum  capacity  or  his  maximum  demand? 
If  he  is  made  to  pay  for  his  maximum  capacity  it  will  tend  to  curtail 


70 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


his  installation,  and  thus  probably  lessen  his  consumption,  and  it 
also  puts  a  premium  on  fraud,  demanding  expensive  and  objection- 
able inspections.  Shall  we  take  his  maximum  demand  for  the  year 
or  for  the  month?  The  central  station  must  provide  for  his  maxi- 
mum yearly  demand,  and  it  seems  to  me  conclusive  that  it  is  his 
maximum  yearly  demand  he  should  pay  for.  Shall  we  make  him 
pay  for  what  he  has  demanded  or  for  what  he  will  demand.'^  If  we 
assume  that  a  central  station  has  but  one  consumer,  and  he  provides 
an  installation  which  will  translate  400  kilowatts,  we  can  hardly 
afford  to  let  him  pay  for  what  he  has  demanded,  but  must  make  him 
pay  the  fixed  charges  for  what  he  may  demand,  as  this  is  what  we 
have  been  compelled  to  provide.  If  we  make  him  pay  for  only  what 
he  has  demanded,  and  this  is  not  equal  to  what  he  may  demand, 
we  must  charge  him  a  correspondingly  higher  rate  for  current,  and 
this  charge  cannot  be  intelligently  fixed  in  advance.     I  propose  that 


vnynwn 


</i\- 


I   I 


we  charge  consumers  at  our  cost  for  readiness  to  serve,  allowing  them 
to  contract  for  whatever  capacity  they  choose,  limiting  the  capacity 
by  suitable  means;  each  contract  to  run  a  year  and  consumer  allowed 
to  increase  his  capacity  at  will,  but  not  lessen  it,  except  at  the  end 
of  a  year. 

The  following  means  have  occurred  to  me  for  limiting  his  demand : 
First — Fusing  to  capacity  demanded. 
Second- — The  use  of  a  circuit-breaker  in  place  of  the  fuse. 

Third — An  interrupter  causing  the  lights  to  wink  when  capacity  paid  for  is 
exceeded. 

Fusing,  to  be  satisfactory,  should  provide  for  a  number  of  relay 
fuses  connected  on  a  multi-point  switch,  permitting  the  customer  to 
throw  on  another  fuse  in  case  he  should  unconsciously  exceed  his 
capacity.     An  automatic  electric  bell  or  vibrator  could  be  used  to 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     71 

notify  him  that  he  is  burning  in  excess  of  his  capacity.  If  desired, 
a  device  as  diagramed  below  could  be  used  on  alternating  currents. 

A  circuit-breaker  can  be  used  in  place  of  the  fuse  if  desired. 

For  direct  current,  a  resistance  can  be  used  in  place  of  the  react- 
ance coil.  x\n  interrupter  can  be  used  on  alternating  currents,  with 
movable  coil  or  movable  core,  which  will  vary  the  electromotive 
force  if  the  maximum  demanded  is  exceeded.  Numerous  simple 
and  satisfactory  appliances  can  be  provided  to  prevent  the  maximum 
demand  being  exceeded. 

I  would  fix  the  charge  for  readiness  to  serve  by  the  minimum  cost 
to  the  station  of  all  fixed  charges  and  fixed  expenses.  I  would  pro- 
portion it  on  the  basis  of:  (a)  consumer,  (b)  meters,  (c)  maximum 
demanded. 

Analysis  of  Costs  of  a  Central  Station 

I  give  below  (page  74)  an  analysis  of  the  results  in  one  station 
for  year  ending  May  1,  1900.  The  total  expenses  are  in  first  column; 
division  of  fixed  and  operating  expenses  in  columns  2  and  3;  a  per- 
centage division  of  fixed  charges  in  columns  4,  5  and  6,  and  their 
corresponding  values  in  columns  7,  8  and  9.  Taxes,  interest  and 
depreciation  are  obtained  by  estimates.  The  station  has  grown  on 
the  instalment  plan,  and  the  investment  cannot  be  accurately 
determined.  I  have,  therefore,  estimated  worth  of  station  as  fol- 
lows to  obtain  my  fixed  charges: 

Real  estate $5,000  @     5%  app.       $250  00 

Building 6,000   @     5%  dep.         .300  00 

Boilers,  heaters  and  pumps 12,000   @     8%  960  00 

Engines  and  condensers 15,000   @     8%  1,200  00 

Generators 12,000   @     8%  960  00 

Switchboard 3,000   @   10%  300  00 

800  poles  set  cross-armed 12,000   @   15%  1,800  00 

60,000  pounds  wire  @  18c 10,800  @i}4%  260  00 

Stringing  wire 3,000 

Transformers 7,500   @     8%  600  00 

1,000  service  connections  @  $5 5,000   @   10%  500  00 

Lightning  arresters  and  incidentals 3,000   @  10%  300  00 

Engineering  and  supervising 6,000 

Legal  expenses  and  rights... 3,000 

Interest  while  building 6,000 

925  meters,  $15 13,875   @  10%  1,387  50 

18,000  lamps.  17c 3,060 

$126,230     6.62%  $8,317  50 

Taxes  @  2%  of  50% 1,262  30 

Interest 6,31 1  50 

$15,891   30 


72  DEVELOPMENT  OF  SCIENTIFIC  RATES 

Income  and  Sales 

$38,480.18.     307,389  K.  W.-hours  sold.     Average  price,  $0.12518. 
Connected  up, 

900  consumers.  925  meters.  18,000  lamps. 

Consumption, 

341.4  K.  W.  per  consumer.     332.1  per  meter.     17.06  per  lamp. 

I  have  assumed  that  the  aggregate  connections  would  equal  two- 
thirds  of  the  lamps  wired  up. 

As  a  matter  of  interest,  I  give  a  graphic  chart  showing  the  cor- 
jesponding  value  of  these  various  expense  items. 


«C«  TO  Or-N    «.  »WiTC«  aoAno . 

W««  TO  BUIL.OINSa 

oil-  «b  IWASTt 


ncTcn.  n^iMTCNANcc __^_  FiforoirTioH/iTC  ■Station  £x^kn9c 

TAXES 


ReiMCWAi.6 . 


REP   TO  POL-t  L(NE  A,C0NO</CTO«a_ 
auPI/TlNTeMOENCC  ^ 

ExECUTive  3Ai.Ar»ica 


rrice  3ai.ab.e3  *  Coi.i.ecT(wa_ 


oepncciATioH. 


This  system  of  charging  will  be  immediately  put  in  use  at  one 
central  station  with  which  I  am  connected,  but  the  conditions  are 
so  unusual  that  you  would  not  be  particularly  interested  in  the 
plans  adopted.  I  am  also  seriously  considering  the  advisability  of 
putting  this  system  in  use  in  another  station  with  which  I  am 
connected.  I  am  afraid  a  charge  of  practically  ten  dollars  per  con- 
sumer will  prove  excessive,  and  have  therefore  fixed  on  an  ar- 
bitrary charge  of  three  dollars  per  consumer,  and  have  raised  my 
demand  charge  from  $1.34  per  lamp  to  $1.50  per  lamp.  I  give  you 
below  a  table  showing  the  cost  per  lamp  for  various  sized  installa- 
tions, based  on  charge  for  readiness  to  serve  of  three  dollars  per 
consumer  per  year;  three  dollars  per  meter  per  year;  $1.50  per 
lamp  demanded  per  year;  and  five  cents  per  kilowatt  for  current, 
on  basis  of  consumption  of  previous  year,  being  25.583  kilowatt  con- 
sumption per  lamp  of  estimated  capacity  demanded: 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     73 


Meters 
installed 

Lamps 
demanded, 

being 

two-thirds 

capacity 

instaUed 

Yearly 

fixed 

charge 

Yearly 
fixed 

charge 
per  lamp 
demanded 

Monthly 

fixed 

charge 

per  lamp 

demanded 

Yearly  charge 
per  lamp  de- 
manded, includ- 
ing current  at 
five  cents  per 
K.  W.-hour 

Average 
monthly  charge 

per  lamp  de- 
manded, includ- 
ing current  at 
five  cents  per 
K.  W.-hour 

1 

$7.50 

7.50 

.625 

8.78 

.731 

2 

9.00 

4.50 

.375 

5.78 

.461 

3 

10.50 

3.50 

.291 

4.78 

.398 

4 

12.00 

3.00 

.25 

4.28 

.356 

5 

13.50 

2.70 

.225 

3.98 

.331 

6 

15.00 

2.50 

.208 

3.78 

.315 

7 

16.50 

2.357 

.196 

3.636 

.303 

8 

18.00 

2.25 

.187 

3.53 

.296 

9 

19.50 

2.155 

.179 

3.435 

.286 

10 

21.00 

2.10 

.183 

3.38 

.281 

12 

24.00 

2.00 

.166 

3.28 

.273 

15 

28.50 

1.90 

.158 

3.18 

.265 

20 

36.00 

1.80 

.15 

3.08 

.256 

30 

51.00 

1.70 

.141 

2.98 

.248 

40 

66.00 

1.65 

.137 

2.93 

.244 

50 

81.00 

1.62 

.135 

2.90 

.241 

60 

96.00 

1.60 

.133 

2.88 

.240 

70 

111.00 

1.585 

.132 

2.864 

.238 

80 

126.00 

1.575 

.131 

2.854 

.238 

90 

141.00 

1.566 

.130 

2.845 

.237 

100 

156.00 

1.56 

.130 

2.84 

.237 

I  give  below  a  table  showing  cost  per  kilowatt  for  various  yearly 
load  factors  from  a  quarter  of  an  hour  to  twenty-four  hours  per  day, 


Receipts 
per  K.  W.-hour 

Receipts  per 

Total  cost 

K.  W.-hour 

K.  W. 

Fixed 

per  K.  W. 

by  proposed 

by  Wright 

Receipts 

day  of  using 

demand  of 

station 

output 
per  year 

expense 
per  K.  W. 
hour  output 

hour  output 
including 
operating 

rate,   $3.00   per 
service,  $3.00 

per  meter,$1.50 
per  lamp  and 

Demand  sys- 
tem; sixteen 
cents  first  two 

per  K.  W . 
hour  by  flat 
rate  of  $12 

expense 

hours,  six 

per  year 

five  cents  per 
K.  W.-hour 

cents  after 

Cents 

Cents 

Cents 

Cents 

Cents 

Va 

36,500 

76.26 

79.39 

69.3 

16. 

262.73 

K 

73,000 

38.13 

41.25 

37.1 

16. 

131.8 

K 

109,000 

25.56 

28.69 

26.4 

16. 

90.9 

1 

146,000 

19.06 

22.19 

21.0 

16. 

65.9 

2 

292,000 

9.53 

12.66 

13.0 

16. 

32.9 

3 

438,000 

6.35 

9.48 

10.3 

12.66 

21.9 

4 

584,000 

4.76 

7.89 

9. 

11.0 

16.45 

5 

730,000 

3.81 

6.94 

8.2 

10.0 

13.15 

6 

876,000 

3.17 

6.30 

7.66 

9.33 

10.95 

7 

1,022,000 

2.72 

5.85 

7.3 

8.85 

9.41 

8 

1,168,000 

2.38 

5.49 

7. 

8.55 

8.22 

10 

1,460,000 

1.91 

5.04 

6.6 

8.00 

6.59 

12 

1,752,000 

1.59 

4.72 

6.33 

7.66 

5:48 

16 

2,336,000 

1.19 

4.32 

6.0 

7.25 

4.11 

20 

2,920,000 

.95 

4.09 

5.8 

7.00 

3.28 

24 

3,504,000 

.79 

3.92 

5.67 

6.83 

2.74 

74 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


S-2 


Percentage 
division 


Value 


1.  Fuel 

2.  Oil  and  waste 

3.  Repairs — 

Boilers   and   en- 
gines   

4.  Rejjairs — 

Dynamos       and 
switchboard. .  .  . 

5.  Repairs — 

Buildings       and 
property 

6.  Station  labor 

7.  Repairs — 

Pole    lines     and 
conductors 

8.  Transformer 

maintenance.  .  . 

9.  Meter 

maintenance.  .  . 

10.  Reading    meters.  . 

11.  Lamp  repairs 

and  renewals.  .  . 

12.  Complaints   and 

gratuitous    work 

13.  Office  salaries  and 

collecting 

14.  Office  rent. 

15.  Stationery,      post- 

age  and   sundry 
expenses 

16.  Fire  insurance.  .  .  . 

17.  Employees'    liabil- 

ity insurance. . . 

18.  Public  liability  in- 

surance  

19.  Superintendence.  . 

20.  Executive    salaries 

21.  Taxes 

22.  Interest 


23.  Depreciation 

24.  Profit 


$2478.00 
176.00 


493.00 


132.00 
4518.00 


1500.00 
400.00 


640.00 
336.00 


1500.00 
600.00 


2150.00 
600.00 


1200.00 
500.00 

500.00 

250.00 
1500.00 
2000.00 
1262.27 
6313.99 
8317.50 
1025.42 


$2478.00 
88.00 


393.00 


32.00 
1338.00 


500.00 
200.00 
400.00 


1500.00 
600.00 
650.00 


600 . 00 


250.00 


Per 

cent 


Per 

cent 


Per 

cent 


$88.00 
100.00 


100.00 
3180.00 


1000.00 
200.00 


240.00 
336.00 


1500.00 
600.00 


600.00 
500 . 00 

250.00 

250.00 
1000.00 
2000.00 
1262.27 
6313.99 
8317.50 


$50 . 00 
1590.00 


500.00 


$240.00 
336.00 


750.00 
300.00 


300 . 00 
250.00 

125.00 

125.00 

500.00 

1000.00 

280 . 88 

1405.06 

1732.50 


138.75 

693.75 

1387.50 


$88.00 
100.00 


50.00 
1590.00 


500.00 
200 . 00 


750.00 
300.00 


300.00 
250.00 

125.00 

125.00 

500.00 

1000.00 

842.64 

4215.18 

5197.50 


$38480 . 18  $10642 . 42  $27837 . 76 


$8908 .  44  $2796 .  00  $16133 .  32 


Expense  per  consumer $9 .  898 

Expense  per  meter 3 .  022 

Expense  per  lamp  wired  up 0.8963 

Expense  per  lamp  demanded  on  station 2.0166 

Expense  per  lamp  demanded  by  consumers 1.3444 

Expense  per  K.  W.-hour  sold 0.03475 


and  the  corresponding  amount  charged  consumers  under  different 
rate  systems.  The  average  receipts  for  current  were  .12518  per 
kilowatt-hour,  which,  if  plotted  on  this  curve,  would  simply  be  a 
straight  line  from  the  vertical  axis  parallel  with  the  horizontal  axis 
at  the  altitude  .12518  cents. 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     75 

This  gives  us  a  profit-and-loss  curve  as  illustrated. 


■    t< 

I' 

1 

^  V 

\ 

i 

^J 

\ 

i 

tr  2« 

\ 

fnoriT  AHO  Loss  CHA/^r 

VI 

1 

s 

•C    J 

tf 

c=J 

-h- 

— 

- 

— 

q 

q 

= 

= 

e 

^ 

;^ 

~ 

=- 

=^ 

J 

=; 

i 

= 

— 

A 

J:  J 

4    /^/«/  /7«/^« 
B  Cost  Line 
Z     Proposecf  Rata 

E   Uniform  rnetvr  Fia 

/ 

A 

of 

"^Jc 

t 

/«  -/Zifper  H.iy. 

0 

■r 

4c 

L 



— 3—7 

_ 

_ 

__ 

_ 

u 

u 

_ 





/^ot/fis  OF  BunNiH* 


I  also  give  graphic  load  chart  of  these  same  data. 


I" 

^  *^ 

^  40 

IS 
to 

s 


" 

- 

M  1  1  1  1 

,..,,>■          ■     1 

Cost  nun  RftTEi  CuftnT 

/?       Flat  Ffate -*/Z.p9r  Year 

B      Cost  Curve 

C       Prooofte.d  Curve 

1  \ 

\ 

.0      Wriaht  nemand    If%and6cenh 

> 

\ 

J 

i     .     .     1 

L 

\ 

\f 

\ 

\ 

^. 

\ 

fe'"^ 

^V 

■ 

\ 

^ 

1 

1 

1 

S=^ 

N 

— l-^ 

_j 

— 

_ 

1 

1 



D 

\ 

- 

i^ 

^ 

— 

= 

= 

= 

= 

«'  i 

1     •• 

w 

r    < 

5 

'     < 

r    J 

>    / 

0    1 

/    / 

8    / 

3  / 

■#   / 

S    1 

6     / 

7    1 

«    / 

»    I 

US    I 

/     2 

l    2 

3   Z 

♦ 

/foors  of  Burning 

Discussion  of  Readiness  to  Serve  Rate  System 
Now  I  expect  to  be  told  that 

First — I  shall  drive  away  consumers. 

Second — That  I  shall  depress  the  peak. 

Third — That  the  people  will  not  favor  the  change. 

I  answer  to  the  first  of  these  objections :  (a)  that  certain  custom- 
ers will  be  driven  away,  but  they  will  be  the  unprofitable  ones;  (b) 
that  enough  of  our  present  unprofitable  ones  will  remain  with  us 


76  DEVELOPMENT  OF  SCIENTIFIC  RATES 

and  will  pay  what  their  service  costs;  (c)  that  many  of  our  present 
unprofitable  consumers  will  abandon  the  use  of  gas  and  oil  for 
long-hour  consumption;  (d)  that  many  other  customers  will  be 
attracted  by  our  low  kilowatt  rate. 

To  the  second  objection:  (a)  I  will  admit  that  I  will  depress  the 
yearly  load  peak  for  a  given  number  of  consumers,  which  I  claim 
will  be  an  advantage  rather  than  a  detriment;  it  will  reduce  inter- 
ruptions of  service,  better  our  regulation,  and  decrease  our  line  and 
transformer  losses;  (b)  but  it  will  encourage  a  more  uniform  load 
peak  throughout  the  year,  lessen  the  investment  for  meters,  and  in- 
crease the  accuracy  of  their  registration  by  enabling  size  installed  to 
be  intelligently  selected. 

Your  third  objection  is  a  matter  of  education,  and  I  ask  (a)  if 
you  expect  a  reduction  in  your  telephone  bill  if  you  do  not  use  it 
for  a  month .^^  (b)  is  not  this  system  the  natural  step  to  take  in 
changing  from  flat  rates?  (c)  is  the  consumer  whose  bill  is  reduced 
apt  to  object  to  the  change.'^  (d)  can  you  afford  to  supply  the  con- 
sumer whose  bill  is  increased  at  less  than  his  schedule  charge.^  (e) 
are  not  all  objections  to  this  proposed  plan  due  to  having  im- 
properly educated  the  public  in  the  past?  If  you  break  your  leg, 
you  expect  the  surgeon  to  cause  some  pain  in  setting  it,  and  this 
pain  is  chargeable  to  the  accident  and  not  to  the  surgeon. 

I  claim  for  this  system: 

First — Greater  uniformity. 

Second — A  tendency  to  produce  a  better  yearly  load  and  better  daily  load. 

Third — An  encouragement  of  long-hour  lighting  and  the  use  of  current  for 
other  purposes  than  lighting. 

Fourth — Ability  to  meet  competition  of  isolated  plants. 

Fifth — A  weeding  out  of  unprofitable  business. 

Sixth — Better    satisfaction    to    consumers. 

Seventh — A  lessening  of  cost  of  production. 

Eighth — A  lessening  of  cost  to  consumer  per  kilowatt. 

Ninth — Ability  to  dispense  with  high-priced,  trouble-breeding,  rate  clerks. 

Tenth — Ability  to  give  better  regulation. 

Eleventh — A  lessening  of  difference  between  registration  of  station  and  con- 
sumers' meters. 

If  desired,  a  clock  arrangement  can  be  used  to  throw  a  heavy 
conductor  in  series  with  the  demand  meter,  to  encourage  heavy  use 
of  current  at  desirable  hours  of  the  day. 

A  deduction  for  power  users  can  be  made  from  the  kilowatt 
rate  for  incandescent-lighting  current,  to  compensate  for  lamp  re- 


EQUITABLE,  UNIFORM  AND  COMPETITIVE  RATES     77 

newals  and  regulation,  and  thus  all  classes  of  consumers  can  be 
supplied  at  a  uniform  rate. 

Many  isolated  plants  are  installed  simply  to  use  idle  capital. 
A  trust  fund  could  be  created,  and  any  customers  wishing  to  provide 
the  investment  included  in  the  charge  for  "readiness  to  serve"  could 
be  accommodated.  I  would  not  object  to  a  deposit  large  enough 
to  pay  their  entire  charge  for  readiness  to  serve,  allowing  them  the 
same  rate  on  their  money  as  paid  on  the  bonds.  A  fund  of  this 
sort  would  do  much  to  silence  their  objections,  even  though  they 
should  not  take  advantage  of  it. 

Conclusion 

The  opportunities  for  development  in  the  central-station  busi- 
ness are  simply  unlimited.  The  instances  are  very  rare  where  a 
properly  equipped  central  station  cannot  profitably  sell  current  at 
less  than  the  cost  of  production  in  an  independent  plant.  There  is 
no  reason  why  we  should  confine  ourselves  to  supplying  small 
powers.  Nothing  should  be  too  big  for  us  to  wrestle  with. 
Many  gas  companies  to-day  sell  more  gas  for  fuel  than  for  lighting, 
and  the  supply  of  pow«r  to  the  electric  business  should  be  what  the 
supply  of  fuel  is  to  the  gas  business. 

If  the  individual  aggregate  demand  of  your  consumers  is  greatly 
in  excess  of  your  maximum  demand,  I  see  no  reason  why  your 
charge  to  them  for  readiness  to  serve  should  not  exceed  the  cost, 
provided  rates  yielding  a  profit  should  prove  profitable  to  the  cen- 
tral station  in  the  long  run. 

The  lower  the  rate  at  which  we  can  give  consumers  current,  the 
greater  our  opportunities  for  extending  its  use  and  finding  new 
uses  for  it.  There  is  a  good  deal  of  human  nature  portrayed  in' the 
story  of  the  salesman  who  told  his  rural  customer  that  a  certain 
stove  would  save  half  the  fuel,  to  which  he  replied:  "  I  guess  I  will 
take  two  of  them  and  save  all  of  it."  Better  have  several  thousand 
customers  planning  means  to  use  additional  current,  and  thus  dimin- 
ish their  kilowatt  cost,  than  to  attempt  to  do  all  of  this  planning 
yourself  and  then  have  to  convince  them  of  the  wisdom  of  your 
ideas. 

Fan  work,  ventilation,  refrigeration,  pumping,  decoration,  sign 
lighting  and  miscellaneous  power  work  can  be  enormously  devel- 
oped by  a  low  rate.  As  you  decrease  your  rate,  your  consumers 
decrease  their  vigilance  of  consumption.     A  low  rate  will  tend  to 


78  DEVELOPMENT  OF  SCIENTIFIC  RATES 

put  many  basement,   hall  and  bathroom   lights  in   constant   use. 
Many  people  are  too  lazy  to  even  "press  the  button." 

Our  salvation  from  many  evils  is  to  have  the  public  understand 
that  fuel  and  labor  are  not  our  only  items  of  expense.  The  public 
get  an  inkling  of  the  expenses  of  these  items  and  conclude  that  the 
biggest  part  of  our  receipts  is  applicable  to  dividends. 

Does  any  one,  in  figuring  service  from  isolated  or  municipal 
plants,  ever  include  interest,  depreciation  and  taxes .^  Is  there  any 
better  way  to  keep  this  in  the  public  mind  than  by  charging  a  cer- 
tain amount  for  "readiness  to  serve?"  If  they  have  to  pay  for 
readiness  to  serve,  they  will  include  this  item  in  their  estimates 
when  they  start  to  figure  what  it  will  cost  them  to  serve  themselves. 

I  recommend  this  system  to  you  as  one  that  will  develop  your 
business,  repress  agitation  for  municipal  ownership  and  the  grant- 
ing of  competitive  franchises,  meet  the  competition  of  isolated 
plants  and  other  means  of  illumination.  I  believe  it  will  reduce 
the  cost  of  production,  better  your  load  factor  and  regulation,  lower 
the  kilowatt  cost  to  the  consumer,  increase  the  stability  of  your 
business,  strengthen  your  securities  and  increase  your  earnings;  in 
short,  prove  a  panacea  for  most  of  the  ills  to  which  the  average 
central  station  is  heir. 


High  Efficiency  Lamps 

Their  Effect  on  the  Cost  of  Light 

to  the  Central  Station 

by 

S.  E.  DOANE 


Presented  before  the 

National  Electric  Light  Association 

May  1910 


(Reprinted  from  Proceedings  National  Electric  Light  Association, 
Vol.  I,  May  1910,  pp.  152-170) 


INDEX 

Page 

Introduction 81 

Historical  Development  of  Cost  Analysis 82 

Premises  Adopted  for  This  Analysis 83 

Cost  Analysis  of  a  Number  of  Central  Stations 83 

Method  of  Analysis 85 

Discussion  of  Analysis 86 

Consumer  Costs 87 

Demands 88 

Load  Factors 89 

Effect  of  High-Efficiency  Lamps  on  Average  Customer 89 

Effect  of  High-Efficiency  Lamps  on  Small  Customer 91 

Effect  of  High-Efficiency  Lamps  on  Large  Customer 93 

Summary  of  Above  Data 95 

Effect  of  Adoption  of  High-Efficiency  Lamps 95 

Conclusion 98 


High- Efficiency  Lamps 

Their  Effect  on  the  Cost  of  Light  to  the  Central  Station 

By  S.  E.  Doane 

1910 

Introduction 

In  beginning  this  paper  permit  me  to  acknowledge  my  indebt- 
edness to  several  central-stations  that  have  freely  opened  their 
books  to  us  and  to  those  who  have  given  us  their  time  for  con- 
sultation and  advice,  and  to  Messrs.  Merrill,  Cooper  and  Eisen- 
menger  of  my  staff  for  working  up  the  material. 

It  is  the  purpose  of  this  paper  to  discuss  briefly  the  effect  of  the 
high-efficiency  lamp  upon  the  cost  of  light  to  the  central  station  as 
developed  by  our  experience,  observation  and  analysis. 

It  became  obvious  to  the  lamp  manufacturer  when  the  new  high- 
efficiency  lamps  came  upon  the  market  that  there  were  many 
problems  connected  with  their  use  concerning  which  we  should  have 
information.  These  lamps  were  so  much  more  efficient  than  any 
with  which  we  had  had  experience  that  there  was  no  basis  from 
which  it  was  possible  to  determine  just  what  course  to  follow^  in 
placing  the  new  lamps  before  the  lighting  industry  and  the  public. 

Under  such  circumstances  our  only  recourse  was  to  determine 
the  best  policy  to  follow  from  a  careful  analysis  and  study  of  the 
conditions  under  which  the  lamps  were  to  be  employed. 

The  author  of  this  paper  consulted  central-station  men  of  much 
experience  from  all  parts  of  the  country  who  operate  all  types  of 
stations.  A  number  of  the  men  of  the  author's  staff  have  been 
employed  for  a  period  of  over  two  years  collecting  and  working  up 
statistics  and  data  from  all  available  sources. 

It  is  most  surprising  to  find  that  although  a  great  many  papers- 
have  been  written  in  the  last  twenty  years  on  this  subject  and 
derived  questions,  practically  the  only  statistical  information  which 
is  available  for  independent  discussion  is  to  be  found  in  the  reports 
of  the  United  States  census  and  in  the  reports  of  the  various  state 
commissions. 


82  DEVELOPMENT  OF  SCIENTIFIC  RATES 

These  figures  are  not  given  in  such  detail  that  they  can  be 
understood  without  further  detailed  knowledge  of  the  business 
itself,  consequently  it  is  through  the  assistance  of  the  central  sta- 
tions, who  have  freely  opened  their  books  to  us  and  to  others 
expert  in  the  industry,  that  we  are  able  to  make  such  detailed 
analysis  as  we  take  pleasure  in  presenting  to  you  today. 

Historical  Development  of  Cost  Analysis 

Among  all  the  papers,  articles,  discussions,  etc.,  the  contribu- 
tions of  two  men  who  have  been  recognized  as  pioneers  in  the  dis- 
cussion of  certain  fundamental  features  of  the  subject  stand  out  by 
themselves.  Practically  all  of  the  contributions  other  than  those 
of  these  two  men  have  dealt  with  details  of  the  broad  plan  of  cost 
analysis  proposed  by  one  or  the  other,  or  both. 

Few  of  the  papers  published  within  the  last  twenty  years  have 
been  based  upon  a  fundamental  cost  analysis,  but  rather  upon  the 
effect  on  the  customer,  etc.*  It  is  not  possible  to  give  due  credit  to 
the  numerous  authors  whose  thoughts  and  opinions  we  have  studied 
with  both  pleasure  and  profit,  and  I  trust  you  will  understand  that 
it  is  not  my  purpose  or  desire  in  presenting  these  figures  to  under- 
rate for  a  moment  the  stupendous  amount  of  work  which  has  already 
been  done  on  this  subject. 

Dr.  John  Hopkinson,  F.  R.  S.,  in  the  presentation  of  his  presi- 
dential address  on  the  "Cost  of  Electric  Supply,"  delivered  before 
the  Junior  Engineering  Society  in  London  in  1892,  succeeded  in 
establishing  a  broad  principle  which  if  it  had  been  recognized  to 
any  extent  previously,  had  never  before  been  presented  to  the 
public  in  such  an  authoritative  or  conclusive  manner  that  it  w^as 
recognized  and  accepted  by  the  industry  as  a  whole.    Dr.  Hopkinson 

*It  is  rather  interesting  to  trace  the  relative  amount  of  attention  given  to  the  rate  question 
during  a  number  of  years  by  noting  the  number  of  references  listed  on  the  subject  in  the  Engineer- 
ing Index.  From  1892  to  1897  six  references  were  made  to  articles  on  rates  appearing  in  American 
publications.  About  this  time  the  Wright  maximum  demand  system  of  charging  awakened 
considerable  interest,  as  we  find  that  in  1898  six  references  were  made  to  articles  on  rates,  five  in 
the  succeeding  year,  three  in  1900  and  four  in  1901.  Then  for  a  period  of  four  years  but  two 
references  were  made  each  year  until  1906,  when  interest  in  the  question  seems  to  have  subsided 
still  more,  as  but  one  reference  was  made.  The  advent  of  the  high  efficiency  lamp  and  the  fact 
that  it  was  becoming  a  commercial  factor  may  have  been  the  cause  for  a  revival  of  interest  in 
regard  to  methods  of  charging,  for  in  1907  five  references  to  the  subject  were  made,  five  in  1908, 
and  four  in  1909.  The  reference  to  tariffs  and  rates  in  foreign  magazines  shows  a  similar  awak- 
ening of  interest  abroad  within  the  last  four  or  five  years,  the  number  of  references  on  the  subject 
from  1892  to  and  including  1906  being  but  eleven,  while  the  next  three  years  showed  a  total  of 
sixteen.  Altogether  seventy-four  references  are  made,  showing  that  considerable  attention  has 
been  given  to  the  subject  of  proper  rates,  tariffs  or  charges  for  the  central-station  service. 


HIGH  EFFICIENCY  LAMPS  83 

divided  cost  into  fixed  and  operating  classifications,  which  division 
is  universally  recognized  and 'conceded  today  to  be  correct. 

Mr.  Doherty,  in  1900,  in  a  paper  before  this  Association,  pre- 
sented the  same  idea,  having  worked  it  up  independently,  but  Mr. 
Doherty  proceeded  to  further  divide  the  fixed  costs,  showing  that 
it  was  not  proper  to  apportion  them  entirely  by  the  customer's 
maximum  demand. 

Inasmuch  as  Mr.  Doherty  absolutely  and  completely  recognizes 
Dr.  Hopkinson's  division  of  costs  into  fixed  costs  and  operating 
costs,  but  goes  further,  in  that  he  separates  the  fixed  cost  into  two 
subdivisions,  it  is  obvious  that  if  we  attempt  our  cost  analysis  on 
the  basis  suggested  by  Mr.  Doherty,  it  is  entirely  possible  for  us  to 
view  it  from  the  standpoint  suggested  by  Dr.  Hopkinson  by  com- 
bining the  two  divisions  of  the  fixed  cost,  whereas  the  contrary  is  not 
true;  consequently  throughout  this  paper  we  have  proceeded  along 
the  lines  indicated  by  Mr.  Doherty  with  the  expectation  that  the 
paper  will  be  of  equal  value  from  either  the  Hopkinson  or  the 
Doherty  standpoint. 

Premises  Adopted  for  This  Analysis 

In  discussing  the  effect  of  the  high-efficiency  lamp  on  central- 
station  costs,  let  us  first  agree  upon  the  premises  on  which  we  base 
our  analysis  and  argument. 

First.  Let  us  agree  that  our  discussion  is  limited  to  the  lighting 
load. 

Second.  Let  us  agree  that  in  order  to  obtain  a  fair  average  and 
to  include  the  yearly  mid-winter  peak  our  analaysis  must  cover  a 
period  of  at  least  one  year. 

Third.  Let  us  agree  that  the  average  equipment  in  the  country 
as  a  whole  must  be  considered  to  be  not  excessive  for  the  maximum 
demand  from  the  standpoint  of  a  cost  analysis. 

Fourth.  Let  us  agree  that  all  items  of  out-go,  including  divi- 
dends, interest,  depreciation,  obsolescence,  and  all  losses,  are  as 
much  items  of  cost  as  the  usual  items  of  coal,  labor,  etc. 

Cost  Analysis  of  a  Number  of  Central  Stations 

As  a  basis  for  the  discussion  which  is  to  follow,  I  wish  to  present 
the  results  of  a  careful  cost  analysis  of  a  number  of  central  stations, 
which  is  summarized  in  Table  I.     In  this  table  four  separate  cases. 


84 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


TABLE  I 

Central-Station  Cost  Analysis 

J 

•er  Cent  of  Total 

Per  Cent  Item  Proportional  to 

Item 

Station  Expense 

Output                 Demand 

Consumers 

a 

12.7 

76.4 

24.6 

General 

b 

14.5 

71.0 

29.0 

Expense 

c 

10.2 

82.8 

17.2 

d 

10.9 

80.0 

20.0 

Weighted 

average 

12.0 

76.9 

23.1 

a 

15.2 

50.2                   26.4 

23.4 

Distributing 

b 

9.7 

44.7                   21.4 

33.9 

Expense 

c 

17.8 

50.6                   24.7 

24.7 

d 

12.8 

31.8                   56.9 

11.3 

Weighted 

average 

14.4 

47.0                   28.9 

24.1 

a 

13.4 

80.7                   19.3 

Generating 

b 

17.7 

74.6                   25.4 



Expense 

c 

32.1 

70.3                   29.7 

d 

32.3 

67.9                   32.1 



Weighted 

average 

23.9 

72.0                   28.0 

a 

8.1 

80.0 

20.0 

Taxes  and 

b 

10.9 

86.2 

13.8 

Insurance 

c 

6.8 

85.9 

14.1 

d 

4.4 

80.0 

20.0 

Weighted 

average 

7.8 

84.0 

16.0 

a 

11.6 

80.0 

20.0 

b 

11.5 

79.5 

20.5 

Depreciation 

c 

9.0 

85.9 

14.1 

d 

6.0 

80.0 

20.0 

Weighted 

average 

9.8 

81.8 

18.2 

a 

39.0 

13.1                   68.1 

18.8 

Interest  and 

b 

35.7 

27.2                   55.1 

17.7 

Dividends 

c 

24.1 

26.4                   61.4 

12.2 

d 

33.6 

8.9                   73.7 

17.4 

Weighted 

' 

average 

32.1 

19.7                   63.7 

10.6 

a 

100.0 

23.5                   58.5 

18.0 

b 

100.0 

27.2                   55.1 

17.7 

Total 

c 

100.0 

37.9                   50.8 

11.3 

d 

100.0 

28.9                   59.5 

11.5 

Weighted 

average 

100.0 

30.3                   55.1 

14.6 

"a"  Represents  a  large  central  station  giving  free  renewals, 
"fc"  Represents  a  large  central  station  giving  free  renewals. 
"c"  Represents  the  average  of  about  70  stations  in  the  East. 
"d"  Represents  the  average  of  about  40  stations  in  the  West. 


HIGH  EFFICIENCY  LAMPS  85 

designated  as  "a,"  "6,"  "c"  and  '*(i,"  are  shown,  together  with 
their  weighted  average. 

In  the  foregoing  table,  "a"  represents  a  large  central  station 
giving  free  renewals,  "6"  represents  another  large  central  station 
operating  under  considerably  different  conditions,  but  also  giving 
free  renewals,  "c"  and  "c?"  represent  the  average  conditions  of  a 
number  of  small  central  stations.  There  are  about  70  central 
stations  in  the  East  represented  in  "c,"  and  about  40  in  the  West 
in  "^." 

We  have  analyzed  the  figures  of  central  stations  of  lesser  size 
than  the  two  large  ones  indicated  by  items  "a"  and  "6,"  and  of 
greater  size  than  those  indicated  by  items  "c"  and  "(i."  The  figures 
are  not  of  interest  excepting  to  confirm  the  findings  in  the  table. 

Method  of  Analysis 

The  percentage  distribution  of  the  total  cost  under  the  items 
"General  Expense,"  "Distributing  Expense,"  "Generating  Ex- 
pense," etc.,  is  shown  separately  for  each  of  the  four  cases  repre- 
sented in  the  column  headed  "Per  Cent  of  Total  Station  Expense." 
Each  of  these  items  has  been  further  analyzed  and  distributed  by 
percentage  under  one  or  more  of  the  headings  as  shown  in  the  last 
three  columns  of  Table  I.  The  portion  of  each  item  charged  to 
"Output"  represents  the  relative  proportion  of  the  cost  which  de- 
pends upon  the  number  of  kilowatt  hours  generated.  The  portion 
charged  to  "Demand"  represents  the  relative  proportion  of  the  cost 
which  depends  upon  the  capacity  of  the  station,  which  in  turn  de- 
pends upon  the  "Demand."  The  portion  charged  to  "Consumers" 
represents  the  relative  proportion  of  the  cost  which  depends  upon 
the  number  of  consumers  connected  and  served.  The  analyses  were 
actually  carried  out  in  considerably  greater  detail  as  to  the  items 
of  expense  considered,  but  have  been  grouped  under  a  few  general 
heads  in  Table  I  in  order  to  present  the  results  in  a  simple  form. 

In  preparing  the  foregoing  table,  each  item  of  cost  has  been 
carefully  considered  and  has  been  listed  under  fixed  cost  or  operating 
cost,  or  has  been  divided  and  part  listed  under  one  head  and  part 
under  the  other.  The  fixed  costs  have  been  divided  into  two  sub- 
divisions, one  of  which  we  call  the  "Demand  Cost,"  the  other  the 
"Consumer's  Cost."  After  a  proper  allowance  for  the  diversity 
factor,  this  demand  cost,  expressed  as  a  fixed  charge  per  kilowatt 
of  maximum  demand,  indicates,  in  our  judgment,  the  amount  which 


86  DEVELOPMENT  OF  SCIENTIFIC  RATES 

would  properly  cover  the  cost  involved  in  supplying  the  maximum 
demand.  This  cost  is  one  of  the  two  components  which  go  to  make 
up  the  total  fixed  cost.  It  may  be  claimed  that  this  demand  cost 
is  not  the  same  per  kilowatt. of  maximum  demand  for  all  sizes  and 
classes  of  customers.  The  advocates  of  this  view  tend  to  increase  the 
demand  cost  per  kilowatt  of  demand  to  the  small  customer,  con- 
sequently any  concession  to  this  view  magnifies  this  feature  of  the 
cost  analysis  for  customers  of  the  average  size  and  smaller  customers. 

The  customer's  component  of  the  fixed  cost,  for  the  average  cus- 
tomer, is  a  cost  which  an  individual  customer  causes,  whether  or  not 
he  actually  consumes  any  current.  It  will  be  claimed  that  this 
customer's  cost  is  also  not  fixed.  The  tendency  in  supporting  such 
a  claim  is  to  decrease  somewhat  such  cost  for  a  small  customer. 

It  is  not  possible,  within  the  confines  of  one  paper,  to  discuss 
these  features  in  detail;  in  fact  a  more  extended  investigation  and 
more  data  are  necessary. 

We  applied  the  following  rules  to  determine  these  cost  divisions: 

If  an  analysis  of  any  item  showed  that  an  increase  of  100  per 
cent  in  the  number  of  customers,  without  the  total  output  or  total 
demand  necessarily  being  increased,  would  presumably  double  the 
expense,  such  we  will  say  as  in  the  reading  of  meters,  we  would 
class  that  item  as  an  expense  which  varied  directly  with  the  num- 
ber of  customers,  that  is,  it  would  be  100  per  cent  consumers* 
expense. 

If  a  particular  item  of  cost  would  be  doubled  with  an  increase 
of  100  per  cent  in  the  capacity  of  the  plant,  even  though  the  num- 
ber of  customers  remained  the  same,  we  would  put  that  item  in 
the  class  which  varied  directly  with  the  demand. 

In  a  similar  way,  items  would  be  classified  under  output. 

Discussion  of  Analysis 

An  analytical  separation  of  these  costs  develops  curious  con- 
ditions. For  illustration,  the  coal  consumed  in  the  station  does  not 
vary  directly  with  the  output.  It  depends  in  part  upon  the  maxi- 
mum demand.  It  takes  more  coal  to  supply  a  given  number  of 
kilowatt-hours  with  a  high  demand  or  peak  than  with  a  low  one. 
This  shows  that  we  must  put  a  portion  of  the  cost  of  coal  under  the 
demand  cost  and  a  portion  under  the  output  cost. 


HIGH  EFFICIENCY  LAMPS  87 

There  are  many  other  fixed  and  operating  costs  which  do  not 
fall  entirely  under  any  single  one  of  these  three  general  divisions  of 
cost.  As  a  further  example,  an  actual  destruction  of  transformers- 
or  apparatus  in  service  could  not  be  said  to  vary  with  demand,  but 
is  rather  a  profit  and  loss  matter.  Losses  through  floods  or  other 
losses  of  such  general  character,  even  though  they  be  costs  of  repair 
of  generating  apparatus  which  it  would  seem  might  belong  to  de- 
mand cost,  might  really  have  to  be  distributed  as  a  loss  and  hence 
be  considered  as  a  negative  profit  and  be  applied  to  all  three  divi- 
sions of  cost. 

There  is  another  phase  of  the  matter.  Invested  capital  may  be 
so  applied  in  anticipation  of  future  needs  that  the  cost  of  an  item 
for  double  the  service  now  being  rendered  need  not  necessarily  be 
double  the  present  cost.  A  building  which  at  present  is  not  being- 
utilized  to  its  full  extent  would  arbitrarily  place  a  higher  charge 
against  a  certain  division  of  cost  than  at  first  thought  would  seem 
to  be  justified.  It  might  be  shown,  however,  that  had  the  building 
been  built  the  exact  size  when  the  plant  was  first  constructed 
further  construction  would  have  been  so  expensive  that  when  the 
proposed  capacity  of  the  larger  building  would  have  been  reached 
in  this  manner  the  larger  building  was  much  the  cheaper,  counting 
all  the  interest,  additional  charges,  taxes,  etc. 

There  are  many  vexing  questions  of  this  character  and  there  is 
much  opportunity  for  extended  consideration  of  this  broad  question 
of  cost  when  once  the  basic  principles  shall  have  been  firmly  estab- 
lished by  usage.  These  questions  of  detail,  however,  are  not  usually 
of  sufficient  magnitude  to  affect  our  broad  deductions  appreciably. 

Many  of  these  questions  arise  when  one  begins  to  consider  the 
classifications  of  the  fixed  costs  or  charges.  These  classifications 
require  the  inclusion  of  some  charges  along  with  those  which  are 
really  fixed,  which  are  not  generally  considered  as  fixed  charges. 
There  are  many  general  office  charges  and  some  station  costs,  such 
as  in  the  class  of  the  supervisory  and  technical  salaries,  etc.,  etc.,. 
which  are  fixed  from  the  standpoint  of  a  going  concern,  but  which 
might  disappear  or  be  reduced  in  case  such  a  concern  was  purchased 
by  another. 

Consumer  Costs 

As  we  go  further  into  this  subject,  the  extreme  importance  of  the 
consumer's  cost,  especially  in  the  case  of  the  small  consumer,  must 


88  DEVELOPMENT  OF  SCIENTIFIC  RATES 

be  conceded,  and,  consequently,  we  have  distributed  these  costs 
with  extreme  care. 

We  beheve  that  the  percentages  we  give  in  the  table  are  con- 
servative and  that  they  indicate,  at  least,  the  nominal  cost  at  which 
a  new  customer  can  be  added  to  the  system  on  the  present  basis. 

We  must  concede  that  every  customer,  no  matter  how  small, 
must  have  a  pair  of  wires  and  necessary  poles,  fixtures,  conduits, 
etc.,  to  bring  the  wires  to  his  premises.  We  must  concede  that  he 
must  have  a  meter  or  some  current-limiting  device  and  that  he 
must  demand  some  attention  in  the  way  of  meter  reading,  inspec- 
tion, billing,  etc.,  etc.  Consequently,  we  must  all  agree  that  any 
.-given  customer,  as  pointed  out  by  Mr.  Doherty,  costs  the  central 
.station  some  definite  minimum  amount  per  year  or  average  month, 
even  though  it  may  be  that  he  uses  no  current  whatever. 

The  three  divisions  of  costs,  indicated  above,  are  commonly 
referred  to  as  the  "Demand  Cost,"  the  "Consumer's  Cost"  and 
the  "Output  Cost,"  and  in  analyzing  costs  of  rendering  service 
and  energy  to  individual  consumers  are  conveniently  expressed  as 
unit  costs  in  terms  of  kilowatt  of  maximum  demand  (or  equivalent 
unit,  such  as  floor  space  illuminated  or  light  delivered),  the  custom- 
er, and  the  kilowatt-hour,  respectively. 

It  is  a  matter  of  much  interest  to  discover  that,  although  indi- 
vidual cases  differ  from  each  other,  the  differences  are  largely  can- 
celled in  the  final  summary.  The  station  which  has  a  large  distri- 
bution net-work,  and  a  few  customers,  will  probably  have  a  rela- 
tively large  cost  per  consumer.  The  plant  which  operates  with 
water  power  or  whose  investment  is  large  for  physical  reasons 
would  have  a  large  demand  cost.  Either  or  both  of  these  cases 
may  be  warranted  by  a  very  low  kw-hour  cost  due  to  the  use  of 
cheap  coal  or  water  power,  etc. 

Demands 

The  two  large  central  stations  mentioned  in  items  "a"  and 
"6"  of  the  table  have  rather  large  average  customers.  Their  aver- 
age customers  consume  about  3.6  and  2.3  kilowatts,  respectively,  at 
the  time  of  maximum  demand. 

The  Massachusetts  Commission  report  would  indicate  that  the 
average  customer  of  Massachusetts  consumes  about  1.5  kilowatts 


HIGH  EFFICIENCY  LAMPS  89 

at  the  time  of  maximum  demand.  The  Wisconsin  Commission 
report  would  indicate  1.8  kilowatts  as  the  average  maximum  de- 
mand. 

The  average  customer  referred  to  in  Mr.  Lloyd's  paper  read  be- 
fore this  Association  a  year  ago  shows  that  the  lighting  customers 
he  considered  consumed  about  0.7  kilowatts  at  the  time  of  maximum 
demand.  We  understand,  of  course,  that  Mr.  Lloyd  does  not 
mean  that  this  is  the  average  size  of  the  Chicago  consumer,  but  is 
only  the  average  of  the  particular  classes  which  he  discussed. 

Load  Factors 

Mr.  Lloyd's  discussion  before  this  Association  meeting  last  year 
also  showed  the  load-factor  to  vary  from  5  to  26  per  cent.  Our  obser- 
vations would  tend  to  confirm  these  figures  and  our  further  analysis 
indicates  that  11  per  cent  is  about  the  right  load-factor  to  apply  to 
the  average  consumer.  We  have  also  assumed  that  a  load-factor 
of  7  per  cent  may  represent  a  short-hour  user  and  a  load-factor  of 
20  per  cent  a  long-hour  consumer. 

The  term  "load-factor"  in  this  connection  is  used  to  mean  the 
percentage  which  the  actual  kilowatt-hours  consumed  in  a  year 
bears  to  the  total  number  of  hours  in  a  year,  namely,  8760  times 
the  maximum  demand. 

So  much  for  the  facts. 

EfiEect  of  High-Efficiency  Lamps  on  Average  Customer 

Let  us  now  discuss  the  effect  of  the  high-efficiency  lamps  on 
the  cost  of  serving  the  central  station  average  customer,  after  which 
we  will  consider  the  effect  of  the  high-efficienc^y  lamps  in  serving 
larger  and  smaller  customers  with  larger  and  smaller  load-factors. 

With  the  figures  in  the  foregoing  portion  of  this  paper  as  a 
basis,  we  have  plotted  some  diagrams  which  show  the  effect  of  the 
adoption  of  the  high-efficiency  lamps  by  a  customer  of  1.6  kilowatts 
maximum  demand  and  11  per  cent  load-factor.     (See  Fig.  1.) 

I  want  to  interpolate  that  the  average  customer  may  or  may 
not  take  1.6  kilowatts  maximum  demand  and  have  an  11  per  cent 
load-factor,  but  whether  this  is  the  maximum  demand  and  load- 
factor  or  not,  the  figures  in  the  diagram  on  page  90  apply  to  the 
average  customer,  because  these  figures  are  based  on  the  percent- 
ages we  obtained  from  an  analysis  of  the  total  cost  of  the  plant. 

We  have  chosen  to  represent  graphically  the  relative  distribu- 
tion of  the  three  items  of  cost  entering  into  the  cost  of  serving  the 


90 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


individual  consumer  under  various  conditions  by  rectangles  divided 
into  three  parts,  which  show,  according  to  the  relative  size  of  the 
parts,  the  magnitude  of  the  several  items  of  cost. 

The  fixed  customer's  cost  is  indicated  by  the  letter  "c."  The 
total  demand  cost  for  1.6  kilowatts  maximum  is  indicated  by  the 
letter  "c?"  and  the  total  cost  of  the  kilowatt-hours  actually  con- 
sumed is  represented  by  the  letter  "o."  In  this  chosen  representa- 
tion "c"  is  for  14.6  per  cent  of  the  total,  "(i"  is  55.1  per  cent,  and  "o" 
is  30.3  per  cent  of  the  total.  This,  you  will  note,  represents  the 
average  figures  obtained  from  the  foregoing  tabulated  analysis. 

ffe/oHve  Cost  of  Proc/ucinq 
a  6/^en /Amount  of  Liqh-t 

Consumer  hov/n^ /.G  Kw.  PTo^^Demar^oncf  //X,  Load  Factor 


Carbon 

Gem 

Tantalum 

Tungsten 


Fresenf  Co3t 

D 


Infermsdiate  Cost 

D  o 


Ultimate  Cost 
D  o 


Output  Cost 

CD 


The  first  single  rectangle  in  Fig.  1  represents  the  cost  of  the 
average  consumer,  which  we  have  assumed  to  have  1.6  kilowatts 
maximum  demand  and  a  load-factor  of  11  per  cent.  Let  us  assume 
now  for  a  moment  that  this  average  customer  changed  to  some  one 
of  three  high-efficiency  lamps,  and  obtained  the  same  amount  of 
light  as  before.  The  result  is  shown  in  the  middle  group  of  dia- 
grarhs  in  which  the  longest  parallelogram  shows  the  effect  on  the 
cost  of  the  adoption  of  the  Gem  lamp,  the  next  the  tantalum  lamp. 


HIGH  EFFICIENCY  LAMPS  91 

and  the  third  the  high-class  tungsten  filament  lamp.  You  will 
note  that  without  adding  any  new  customers,  the  central  station 
is  unable  to  reduce  the  demand  cost,  which  is  charged  against  the 
customer,  and  that  the  sole  reduction  in  cost  is  therefore  due  to 
the  reduction  in  the  number  of  kilowatt-hours  required  to  produce 
the  same  amount  of  light  in  a  more  efficient  manner. 

In  the  illustration  before  you  the  immediate  reduction  of  cost 
due  to  the  adoption  of  the  Gem  lamp  is  8.7  per  cent,  the  reduction 
due  to  the  adoption  of  the  tantalum  lamps  is  13  per  cent,  and  the 
reduction  due  to  the  adoption  of  the  high-class  tungsten  filament 
lamp  is  19.5  per  cent.  It  is  evident,  therefore,  that  even  though 
the  consumer's  consumption  of  energy  is  reduced  two-thirds,  the 
cost  of  light  is  only  reduced  by  two-thirds  of  that  portion  of  the  cost 
which  varies  with  the  kilowatt-hours.  The  total  cost  reduction  is, 
therefore,  only  about  20  per  cent  instead  of  60  per  cent. 

In  all  these  assumptions  the  renewal  cost  of  the  lamp  has  not 
been  considered  to  have  increased,  since  it  is  believed  that  the  gen- 
eral practice  of  central  stations  everywhere  is  to  charge  the  differ- 
ence between  the  cost  of  the  carbon  lamp  and  high-efficiency  lamps 
to  the  customers,  and  as  this  cost  of  light  is  being  considered  from 
the  standpoint  of  the  central  station  the  cost  of  renewal  does  not 
figure  therein. 

In  the  same  diagram  the  lowest  group  composed  of  the  three 
short  rectangles  shows  what  happens  when  the  station  has  added 
enough  customers  to  utilize  entirely  its  output  after  every  cus- 
tomer has  been  changed  to  high-efficiency  lamps.  This  shows  that 
by  the  adoption  of  the  high-class  tungsten  filament  lamp  the  cost 
of  producing  light  for  the  average  consumer  is  reduced  55  per  cent. 

A  tabular  expression  of  these  diagrams  is  given  later  in  a  com- 
plete summary. 

Effect  of  High-Efficiency  Lamps  on  Small  Customer 

The  total  cost  to  the  station  for  the  individual  customer  can  be 
determined  when  the  maximum  demand  and  the  load-factor  are 
known.  Assuming  a  customer  of  small  size,  having,  we  will  say, 
0.5  l^ilowatts  as  maximum  demand,  let  us  analyze  the  cost  condi- 
tions with  both  short  and  long  hour  use  as  represented  by  load- 
factors  of  7  per  cent  and  20  per  cent  respectively.  The  results  are 
indicated  in  Figures  2  and  3. 


92  DEVELOPMENT  OF  SCIENTIFIC  RATES 

ffe/af/'/e  Cost  of  Proolucing 
a  6/\^en  /Amount  of  Light 

Consumer  having  O.S KwJ^m.OemancI  cmd  7Z Loocirczfcr 


Corbon 


F'resenf  Cost 
c D  a 


Infermeolioii-e  Cos-h 
c  D  o 


U/timafTe   Cosf 
c  Do 


Gem 

Tantalum 

Tungsten 

Consumer  Co  si-  DemcmdCost  OufpufCoei- 


I  will  say  that,  if  our  assumption  of  1.6  kilowatts  as  the  average 
demand  of  a  customer  is  wrong,  this  quantity  0.5  kilowatts  is  also 
wrong  numerically,  but  still  illustrates  correctly  the  effect  on  the 
cost  of  serving  a  customer  of  one-third  the  average  size,  whatever 
that  average  size  may  be. 

We  find  that  when  such  a  customer  is  a  short-hour  user,  the 
cost  of  kilowatt-hours  is  only  about  16  per  cent  of  the  total  cost, 
when  the  customer  uses  carbon  lamps,  and  is  only  about  6  per  cent 
of  the  total  cost  when  the  customer  uses  the  highest  efficiency  lamp, 
and  we  further  develop  the  astonishing  fact  that  even  when  such  a 
customer  receives  the  maximum  benefit  of  this  new  lamp  by  addi- 
tion of  enough  customers  to  employ  the  entire  capacity  of  the  cen- 
tral station,  when  utilized  with  high-efficiency  lamps,  the  cost  of 
actual  energy  consumed  is  still  only  about  10  per  cent  of  the  total 
cost  of  carrying  such  a  customer.  Further  reference  to  the  com- 
parative values  shows  that  even  in  the  case  of  a  long-hour  user 
having  the  same  maximum  demand  the  kilowatt-hours  consupied 
cost  the  central  station  but  a  very  small  part  of  the  total  cost  for  the 
customer.  Most  of  the  cost  in  the  case  of  the  small  consumer  is 
involved  in  supplying  service  of  one  character  or  another.     These 


HIGH  EFFICIENCY  LAMPS 


93 


Ffe/ofive  Cost  ofF^oducmq 
a  Gtven  ft  mount  of  L/qht 
Consumer  havinq  0. 5  Kv^  rfax  Demand  and  to  K/oaalfacrtor 


Present  Cosf 
z  D  O 


Intermed/afe  Cost 
ODD 


Carbon 

Gem 

Tonta/uni 

Tun(^st^n 

Gerr? 

Ibnta/um 

Tungsten 

Consumer  Cast    DemandCost 


Ultimate  Cost 
c  D        o 


OutpofCost 


Fiq.  5 


diagrams  indicate  that  the  high-efficiency  lamp  reduces  the  cost 
materially  of  producing  a  given  amount  of  light  for  such  a  customer, 
but  that  in  the  case  of  the  average  small  customer  the  reduction  in 
cost  is  in  no  sense  comparable  with  the  reduction  in  energy  required 
for  a  given  quantity  of  light. 

Reference  to  the  diagram  shows  further  that  the  cost  of  supply- 
ing current  is  a  small  percentage  of  the  total  cost,  and  a  reduction 
of  a  small  percentage  in  that  cost  gives  almost  no  saving  in  cost 
whatever.  If  we  succeed  in  fully  loading  up  the  station  with  lamps 
of  higher  efficiencies,  the  cost  of  the  smaller  customers  will  be  re- 
duced to  82,  73  and  60  per  cent  of  the  present  cost  with  Gem, 
tantalum  and  tungsten  filament  lamps,  respectively. 

Effect  of  High-Efficiency  Lamps  on  Large  Customer 

Figures  4  and  5,  representing  a  large  consumer,  show  a  very 
different  situation,  as  it  will  be  observed  that  the  consumer's  cost 
is  an  insignificant  proportion  of  the  whole.  The  first  reduction  in 
cost  due  to  the  use  of  high-efficiency  lamps  by  a  short-hour  cus- 
tomer, of  this  size,  is  only  about  15  per  cent  when  such  a  customer 
uses  the  highest  efficiency  lamp   most   advantageously. 


94 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


ffela  tive  Cos  t  of  Frodu  cincj 

a  Qiven  /f mount  of  Lic^ht 

Consumer  JiQnng  20 Kw.  rfaK-Dernanct Qnd  T/doad factor 


Carbon 

Tan  fa /urn 
Tungst&n 


Sca/e  /O  to  I 

Present  Cosf- 

D  


Inter  mediate  Cost 
D 


Ultimate  Cost 
D  o 


ConsumerCost 


OemondCosf 


Output  Coat 


rig  4 

Relative  Cost  of  proa/ucinq 
a  Given  /Amount of  Light 
Consumer  tiari'n^  ^OK^JJaxOemandonclZOfs  load  factor 


5ca/e  /O  to  / 

Present  Cost 


ConsumerCost  nern<^nc/  Cost 

rig.  5 


Output  Cost 


HIGH  EFFICIENCY  LAMPS  95 

Summary  of  Above  Data 

A  total  summary  of  the  foregoing  diagrams  follows: 

TABLE  II 
Relative  Cost  of  Serving  Various  Customers 

Present         Intermediate  Cost  Ultimate  Cost 

Cost  Tanta-      Tung-  Tanta-      Tung- 

CoNsrMER  Carbon        Gem  lum  sten  Gem  lum  sten 

Per  Cent  Per  Cent  Per  Cent  Per  Cent  Per  Cent  Per  Cent  Per  Cent 

Average 100  91.3  87.0  80.5  75.6  63.8  45.1 

Small— Short-hour 100  95.5  93.2  89.8  82.5  73.8  60.6 

Small— Long-hour 100  88.1  85.0  77.4  80.0  70.0  54.9 

Large— Short-hour 100  92.7  89.1  83.6  71.8  57.8  36.7 

Larg^Long-hour 100  85.9  78.8  68.2  71.7  57.5  36.3 

Kw  Load 

Consumer  Maximum  Demand  Factor 

Average 1.6  11  per  cent 

Small— Short-hour 0.5  7"       « 

Small— Long-hour 0.5  20"       " 

Large — Short-hour 20.0  7  " 

Large — Long-hour 20. 0  20  " 

Each  consumer  is  assumed  to  use  the  same  total  amount  of  light 
after  changing  to  the  high-efficiency  lamps  as  was  used  with  the 
carbon  lamps. 


Effect  of  Adoption  of  High- Efficiency  Lamps 

The  logical  effect  of  the  high-efficiency  lamp  is  to  increase  the 
number  of  small  consumers.  This  means  an  increase  in  the  pro- 
portion of  the  central-station  expense  for  labor  in  connection  with 
the  distributing  system  and  the  accounting,  etc.,  which  we  have 
classified  under  "Consumer's  Cost."  The  addition  of  many  new 
customers  will  improve  the  load-factor  of  the  station  somewhat,  as 
there  is  no  reason  to  assume  that  the  day  load,  which  is  not  a  lamp 
load,  will  not  increase  with  an  increase  in  the  number  of  customers, 
even  though  the  current  consumed  at  the  time  of  maximum  demand 
does  not  increase  because  of  the  high-efficiency  lamps. 

It  is  of  course  obvious  that  a  central  station  could  always  take 
care  of  an  increased  number  of  customers,  without  using  high- 
efficiency  lamps,  by  increasing  the  size  of  the  plant,  but  it  is  also 
obvious  that  the  use  of  the  high-efficiency  lamps  will  allow  it  to 
greatly  increase  the  number  of  customers  served  without  materially 
increasing  the  station  and  generating  investments. 


96 


DEVELOPMENT  OF  SCIENTIFIC  RATES 


Table  III,  which  follows,  shows,  on  the  basis  of  the  foregoing  sta- 
tistics, what,  in  a  general  way,  might  be  expected,  when  that  time 
in  the  future  arrives,  when  all  of  the  central-station  customers  have 
changed  to  the  highest  efficiency  lamps.  Of  course,  we  know  that 
the  time  will  never  come  when  every  lamp  on  the  circuit  will  be  of 
the  highest  efficiency.  We,  however,  can  assume  any  value  we  may 
desire  and  for  the  exception  still  use  the  table  which  follows. 


TABLE  III 

Effect  on  Station  Cost  and  Output  Produced  by  Adoption 
of  the  Highest  Efficiency  Lamps 

(Assuming  that  each  Consumer  produces  the  same  amount  of  light  with  highest  efficiency  lamps 
as  with  the  lamps  of  low  efficiency) 


Number  of 

Consumers  in 

Per  Cent  of 

the  Number 

Supplied  at 

Present 

with  Low 

Efficiency 

Lamps 

Per  Cent 

Con- 
sumer 
Per  Cent 

Cost  to  Station 

Demand        Output 
Per  Cent      Per  Cent 

Total 
Per  Cent 

Kw-hrs.  Con- 
sumed and 
Maximum    De- 
mand in  Per 
Cent  of  that 
with  Low 
Efficiency 
Lamps 
Per  Cent 

Relative  Cost 

*Per          Per  Con- 
Kw-hr.           sumer 
Per  Cent      Per  Cent 

.100          ) 

1 

using  low     f 

efficiency     I 

lamps        ; 

14.6 

1 

55.1 

30.3 

100. 0 

100.0 

100.0 

100.0 

Changed  to 
the  following 

per  cent 

using  higher 

efficiency 

lamps 

100 

14.6 

55. 1 

10.8 

80.5 

35.7 

225.0 

80.5 

110 

16.1 

55.1 

11.9 

83.1 

39.3 

212.0 

75.5 

120 

17.5 

55.1 

13.0 

85.6 

42.9 

200.0 

71.4 

130 

19.0 

55.1 

14.1 

88.2 

46.4 

190.0 

67.8 

140 

20.4 

55.1 

15.1 

90.6 

50.0 

181.0 

64.7 

150 

21.9 

55.1 

16.2 

93.2 

53.6 

174.0 

62.1 

160 

23.4 

55.1 

17.3 

95.8 

57.2 

168.0 

59.8 

170 

24.8 

55.1 

18.4 

98.3 

60.7 

162.0 

57.8 

180 

26.3 

55.1 

19.5 

100.9 

64.3 

157.0 

56.1 

190 

27.7 

55.1 

20.6 

103.4 

67.9 

152.0 

54.4 

200 

29.2 

55.1 

21.6 

105.9 

71.4 

148.0 

52.9 

210 

30.7 

55.1 

22.7 

108.5 

75.0 

145.0 

51.7 

220 

32.1 

55.1 

23.8 

111.0 

78.6 

141.0 

50.4 

230 

33.6 

55.1 

24.9 

113.6 

82.2 

138.0 

49.6 

240 

35.0 

55.1 

26.0 

116.1 

85.7 

135.0 

48.4 

250 

36.5 

55.1 

27.1 

118.7 

89.3 

133.0 

47.5 

260 

38.0 

55.1 

28.1 

121.2 

92.9 

130.0 

46.6 

270 

39.4 

55.1 

29.2 

123.7 

96.5 

128.0 

45.8 

280 

40.9 

55.1 

30.3 

126.3 

100.0 

126.0 

45.1 

♦Please  do  not  confuse  this  with  the  output  cost  per  kilowatt-hour  which  remains  practically 

constant  throughout. 


HIGH  EFFICIENCY  LAMPS  97 

The  table  is  drawn  up  on  the  assumption  that  every  customer  in 
the  future  will  have  changed  to  the  use  of  high-efficiency  lamps. 
It  is  anticipated,  of  course,  that  between  now  and  the  time  when 
this  condition  will  have  been  reached,  that  each  station  will  have 
increased  its  number  of  customers;  consequently,  we  have  made 
our  assumption  to  include  all  percentages  beginning  with  no  in- 
crease in  customers  and  ending  with  180  per  cent  increase  in  cus- 
tomers, at  which  time,  the  station  will  be  again  entirely  loaded. 
This  table,  of  course,  is  drawn  up  on  the  further  assumption  that  a 
customer  will  not  increase  the  amount  of  light  he  uses  at  peak  hours. 
I  firmly  believe  this  assumption  is  warranted  in  the  case  of  the  do- 
mestic user  and  that  it  is  warranted  in  essence  in  all  cases,  as  I 
believe  that  we  are  rapidly  reverting  to  a  condition  of  somewhat 
increased  light,  perhaps,  but  not  to  an  increase  sufficiently  great 
to  affect  materially  this  assumption. 

I  would  like  to  say  just  a  word  as  to  the  use  of  this  Table  III. 
Let  us  assume  that  a  station  is  adding  new  customers  on  the  high- 
efficiency  basis  at  the  rate  of  about  9  per  cent  a  year.  Let  us  also 
assume  that  a  period  of  time,  say  three  years,  elapses  before  all  the 
present  customers  will  have  changed  to  the  highest  efficiency  lamps. 
At  that  time  the  station  will  be  supplying  130  per  cent  of  its  present 
number  of  customers,  all  of  whom  will  be  using  lamps  of  the  highest 
efficiency.  Running  down  the  left-hand  column  to  130  percent, 
and  reading  across  to  the  final  figures  at  the  right,  it  shows  that  the 
average  customer  at  the  end  of  three  years  will  cost  the  central 
station  67.8  per  cent  as  much  as  he  does  to-day — even  though  he 
uses  high-efficiency  lamps  and  consumes  only  about  one-third  as 
much  current.  We  find  by  reference  to  the  sixth  column  that  the 
actual  kilowatt  output  in  such  case  will  be  only  46  per  cent  of  what 
it  is  today. 

Some  one  has  asked  me,  upon  reading  this  paper,  why  we  did 
not  deal  with  other  factors  in  the  cost  of  operating  a  central  station 
than  that  of  lighting,  and  my  reply  was  that  lighting  w^as  the  only 
subject  upon  which  I  considered  I  had  any  right  to  address  this 
Association.  This  46  per  cent  of  present  output  indicates  only  the 
current  used  for  lighting.  I  have  no  idea  there  is  any  statioa 
whose  load  is  so  purely  lighting  that  when  the  30  per  cent  addi- 
tional customers  have  been  obtained  they  will  not  actually  have  a 
greater  output  than  46  per  cent  of  that  at  present,  due  to  the  day 
load  and  the  power  load. 


98  DEVELOPMENT  OF  SCIENTIFIC  RATES 

This  table  clearly  shows  that  those  costs  which  we  have  classed 
as  the  consumer's  costs,  which  are  the  costs  per  customer  for  dis- 
tributing the  current  generated,  are  the  costs  which  concern  the 
central  station  to  a  constantly  increasing  extent.  The  investment 
in  meters  and  the  length  of  line  necessary  to  run  to  reach  a  customer, 
the  location  of  meters  to  facilitate  reading  and  details  of  this  char- 
acter will  be  of  considerably  greater  importance  to  the  station  man 
than  the  efficiency  of  the  generating  apparatus. 

It  has  been  suggested  to  the  writer  that  the  customer's  cost  can 
be  reduced  50  per  cent  when  several  ends  have  been  accomplished, 
among  which  is  the  universal  adoption  of  a  cheap  meter,  a  current- 
limiting  device  or  something  equivalent  to  either,  or  both,  etc.,  etc. 
This  is  a  matter  of  speculation,  but  it  is  interesting  to  observe  from 
the  table  that  such  a  50  per  cent  decrease  would  allow  the  central 
station  to  carry  180  per  cent  more  customers  with  the  same  gross 
cost,  at  which  time,  the  cost  per  kilowatt  would  be  no  greater  than 
at  present,  and  at  which  time,  the  total  average  cost  per  customer 
(please  do  not  confuse  this  with  the  customer's  component  of  the 
fixed  costs),  on  the  basis  of  our  assumption,  would  be  decreased 
to  36  per  cent  of  the  present  total  average  cost  per  customer. 

It  is  most  interesting  to  note  that  when  a  station  has  added  80 
per  cent  more  customers  that  its  total  cost  will  have  again  reached 
the  present  cost,  but  that  the  cost  per  kilowatt-hour  will  be  about 
60  per  cent  greater  than  at  present.  It  is  most  interesting,  further- 
more, in  showing  that  even  when  the  station  again  becomes  fully 
loaded  the  cost  per  kilowatt-hour  will  be  about  25  per  cent  greater 
than  it  is  at  present. 

Conclusion 

The  effect  of  the  high-efficiency  lamp  has  been  to  profoundly 
modify  commercial  practice.  The  possibility  of  these  lamps  being 
made  more  efficient  as  the  weeks  pass  makes  it  necessary  for  the 
central  station  to  adopt  policies,  programmes  and  methods  which 
not  only  will  take  care  of  the  present  high-efficiency  lamp  situation, 
but  which  will  provide  for  any  increase  in  efficiencies  in  the  weeks, 
months  and  years  to  come. 

Ductile  tungsten  wire  has  been  produced,  and  it  is  a  most  rea- 
sonable expectation  that  the  high-class  tungsten  filament  lamps 
ultimately  will  be  hardy  and^capable  of  satisfactory  employment  in 
houses  or  elsewhere  where  the  supposed  fragility  has  been  argued 


HIGH  EFFICIENCY  LAMPS  99 

against  them.  Every  customer  on  a  central-station  circuit  will 
ultimately  purchase  and  use  lamps  of  this  character.  The  situation 
contains  a  menace  and  a  promise,  a  menace  which  cannot  be  ignored, 
a  promise  which  must  be  fulfilled. 

The  menace  is  in  the  fact  that  the  reduction  in  the  cost  of  pro- 
viding light  to  the  average  customer  can  never  be  so  great  as  the 
customer  expects. 

He  inevitably  associates  that  two-thirds  reduction  in  current 
consumed  with  a  two-thirds  reduction  in  cost. 

The  decrease  in  cost  of  furnishing  light  with  the  high-efficiency 
lamp  is  almost  entirely  measured  by  the  ability  of  the  central  sta- 
tion to  take  on  additional  consumers  w^ho  can  assist  in  bearing  the 
fixed  expenses. 

The  promise  lies  in  the  opportunity. 

Never  in  the  history  of  our  industry  has  there  been  the  oppor- 
tunity which  now  presents  itself  to  the  central  station  for  increasing 
the  number  of  its  customers,  decreasing  the  cost  to  each  of  them,  and 
increasing  profit  to  itself,  through  the  use  of  the  high-efficiency 
lamps. 


Demand  and  Diversity  Factors 
and  Their  Influence  on  Rates 


h 
J.  R.  CRAVATH 


(Reprinted  from  The  Electrical  World 
Vol.  LVI,  Sept.  8,  1910,  pp.  567-570) 


INDEX 

Page 

Introduction — Definitions 103 

Importance  of  Demand  Factor  and  Diversity  Factor 103 

Standing  Costs  and  Running  Costs 104 

Determination  of  Demand  Factors  and  Diversity  Factors.  ...  105 

Demand  Factors 106 

Diversity  Factors 109 

Application  of  These  Factors  to  Rate  Making 113 


Demand  and  Diversity  Factors 
and  Their  Influence  on  Rates 

By  J.   R.   Cravath 

1910 
Introduction — Definitions 

Demand  factor  is  defined  as  the  highest  percentage  of  connected 
load  which  is  ordinarily  in  circuit.  Thus,  if  a  central-station  con- 
sumer has  10  kw  in  lamps  connected  and  his  highest  maximum 
demand  is  5  kw,  he  would  be  rated  as  having  a  demand  factor  of 
50  per  cent. 

Diversity  factor  is  commonly  defined  as  the  ratio  of  the  sum  of 
the  maximum  demands  of  a  given  group  of  consumers  at  different 
times  to  the  actual  maximum  demand  made  by  the  group  at  one 
time.  This  likewise  frequently  can  best  be  expressed  in  per  cent^ 
For  example,  a  group  of  10  consumers  connected  on  a  certain 
secondary  main  might  cause  a  maximum  demand  of  3  kw  on  the 
transformer  supplying  that  main;  but  if  a  maximum-demand  meter 
were  installed  on  each  consumer's  service  the  sum  of  the  maximum 
demands  recorded  by  these  meters  for  any  month  might  be  9  kw  in 
certain  classes  of  work.  Expressed  in  per  cent,  the  diversity  factor 
of  this  load  in  relation  to  the  transformer  would  be  33.33.  This 
difference  between  the  sum  of  the  individual  maximum  demands  of 
each  consumer  and  the  actual  maximum  demand  on  the  transformer 
is,  of  course,  caused  by  the  fact  that  the  maximum  demands  of  the 
various  consumers  do  not  occur  at  the  same  time.  In  other. words, 
there  is  diversity  in  time  of  maximum  demand. 

Importance  of  Demand  Factor  and  Diversity  Factor 

The  existence  of  diversity  and  demand  factors  in  central- 
station  business  has  been  recognized  since  the  earliest  days,  although 
it  is  only  recently  that  these  brief  terms  have  come  into  use  to  ex- 
press these  relations.  It  may  also  be  said  that  although  the  central- 
station  industry  has  been  dependent  for  its  very  existence  on  di- 
versity and  demand  factors,  the  study  of  these  factors  has  not  been 
as  thorough  as  it  should  have  been.  It  is  only  recently  that  much 
activity  has  been  shown  in  the  study  of  these  factors,  which  have  an 


104  DEVELOPMENT  OF  SCIENTIFIC  RATES 

all-important  influence  on  the  rates  that  central-station  companies 
can  afford  to  make,  and  hence  are  at  the  very  foundation  of  the 
industry.  The  reason  of  their  importance  is  that  so  large  a  per- 
centage of  the  cost  of  supplying  electric  service  is  frequently  made 
up  of  certaili  fixed  charges,  such  as  interest,  depreciation  and  taxes, 
which  are  brought  about  by  the  necessity  of  providing  a  certain  in- 
vestment to  take  care  of  a  certain  connected  load.  It  is  evident 
that  the  larger  the  amount  of  apparatus  required  to  supply  1  kw 
of  connected  load  the  greater  must  be  the  fixed  charges  per  kilowatt 
connected. 

Standing  Costs  and  Running  Costs 

The  percentage  of  the  cost  of  serving  a  consumer  which  is  due 
to  fixed  charges  and  the  percentage  due  to  variable  operating  ex- 
penses differ  according  to  the  class  of  consumer.  The  fixed  charges 
are  seldom  less  than  10  per  cent  and  may  be  as  high  as  100  per  cent 
of  the  cost  of  service.  The  fewer  the  hours  per  year  the  service  is 
used  the  greater  the  percentage  cost  composed  of  fixed  charges. 
For  example,  if  a  certain  consumer  contracts  for  electric  service  and 
the  company  installs  meters,  lines,  generating  capacity,  etc.,  to 
supply  him,  and  if  that  consumer  uses  no  electrical  energy  whatever 
during  the  year,  the  cost  of  serving  him  evidently  is  made  up 
entirely  of  fixed  charges  on  the  investment  required,  plus  a  small 
amount  for  keeping  books,  reading  the  meter  and  maintaining  the 
office.  If,  on  the  other  hand,  the  consumer  used  his  entire  con- 
nected load  8760  hours  in  a  year,  his  fixed  charges  should  be  divided 
into  8760  parts  to  determine  the  amount  a  kw-hour.  The  great 
majority  of  ceutral-station  customers,  however,  use  the  service  but 
a  limited  number  of  hours  a  year. 

The  relative  proportion  of  total  expenses  chargeable  to  the  three 
heads — fixed,  operating  and  consumers'  charges — has  been  a  matter 
of  considerable  investigation.  It  is  not  likely  to  be  exactly  the  same 
for  any  two  plants.  It  is  of  interest,  however,  to  cite  a  few  ex- 
amples from  various  recent  published  investigations.  A  very 
thorough  investigation  of  this  division  of  expenses  was  made  by  the 
Wisconsin  commission  in  the  recent  Madison  Gas  &  Electric  Com- 
pany case,  decided  March  8,  1910.  For  the  year  1908,  the  commis- 
sion found  by  one  method  of  analysis  that  16.7  per  cent  of  the  total 
cost  was  caused  by  the  expenses  which  are  the  same  for  each  con- 
sumer, entitled  "consumer  expenses";  21.6  per  cent  were  expenses 
proportional  to  the  demands  of  each  consumer,  and  61.7  per  cent 


DEMAND  AND  DIVERSITY  FACTORS  105 

were  variable  operating  expenses  proportional  to  the  kw-hours' 
output.  By  another  method  of  analysis  58. "2  per  cent  of  the  ex- 
penses were  chargeable  to  output,  being  proportional  to  kw-hours, 
and  41.8  per  cent  were  chargeable  to  demand.  In  the  case  of  the 
Ripon  Light  &  Water  Company,  decided  March  28,  1910,  the  Wis- 
consin commission  assigned  about  39  per  cent  to  capacity  charges 
and  61  per  cent  to  output  charges. 

In  a  paper  before  the  last  N.  E.  L.  A.  convention  Mr.  S.  E. 
Doane  gave  the  results  of  central-station  cost  analysis  from  70  small 
central  stations  in  the  East,  40  small  central  stations  in  the  West  and 
two  very  large  central  stations.  In  this  analysis  it  appeared  that 
of  the  total  cost  30.3  per  cent  was  proportional  to  output,  55. 1 
per  cent  proportional  to  demand,  and  14.6  per  cent  proportional 
to  the  number  of  consumers. 

In  a  paper  before  the  Missouri  Electric,  Gas,  Street  Railway  and 
W^ater  Association,  in  April,  1909,  Mr.  C.  W.  Hough  gave  an  an- 
alysis of  the  cost  of  central-station  service,  taking  as  a  basis  the 
statistics  given  by  the  last  United  States  census  report  on  the 
electrical  industry.  He  reached  the  conclusion  that  the  total  cost 
should  be  divided  into  consumer  charges,  5  per  cent;  capacity  charge, 
35  per  cent,  and  output  charge,  60  per  cent.  These,  Mr.  Hough 
said,  represented  the  average  results  as  shown  by  the  Government 
reports.  The  proportions  chargeable  to  the  various  items  should, 
of  course,  be  investigated  for  each  individual  company,  rather  than 
taken  from  general  averages,  when  any  specific  case  is  being  in- 
vestigated with  a  view  to  adjusting  rates.  The  figures  given  are  of 
interest  merely  as  showing  what  figures  have  been  obtained  in  some 
cases.  If  it  is  assumed  that  at  least  30  per  cent  to  40  per  cent  of  the 
average  cost  of  serving  consumers,  and  perhaps  more,  is  caused 
by  the  maximum  demand  of  such  consumers,  the  importance  of 
determining  what  actual  maximum  demand  these  consumers  put 
upon  the  station  is  evidently  important. 

Determination  of  Demand  Factors  and  Diversity  Factors 

It  is  an  easy  matter  to  determine  the  ratio  of  total  connected  load 
to  maximum  demand  on  the  central  station  where  the  company  has 
a  connected  load  of  record.  However,  the  determination  of  this 
ratio  and  the  determination  of  the  percentage  of  the  total  cost 
chargeable  to  fixed  expenses  is  by  no  means  suflScient  to  afford  a  basis 
for  rates.  In  other  words,  averages  are  worth  little  when  the  charac- 
ter of  service  required  by  various  consumers  differs  so  greatly.     The 


106  DEVELOPMENT  OF  SCIENTIFIC  RATES 

attempt  must  be  made  to  determine  as  nearly  as  possible  the  actual 
demand  and  diversity  factors  of  different  kinds  of  loads  in  order  that 
the  central-station  management  may  know  what  proportion  of  the 
fixed  investment  charges  must  be  carried  by  these  different  kinds. 
If  this  is  not  done  some  profitable  business  is  likely  to  be  lost  for  lack 
of  a  proper  rate  schedule,  while  other  unprofitable  business  is 
obtained. 

There  are  a  number  of  links  in  the  chain  between  the  consumer's 
lamps  and  the  generators  at  the  power  plant.  First,  the  demand 
factor  or  ratio  of  connected  load  to  maximum  demand  must  be 
studied  at  each  consumer's  premises  and  then  the  diversity  factors 
at  different  points  between  the  consumer  and  the  power  plant. 

Beginning  at  the  consumer's  end,  the  first  step  is  to  determine 
the  demand  factor  or  the  ratio  of  the  consumer's  maximum  demand 
to  his  connected  load.  This  determines  the  size  of  meter  and  service 
wires  necessary  and  the  consequent  investment.  Next,  in  an  alter- 
nating-current system,  comes  the  diversity  factor  between  the  var- 
ious consumers  and  transformers,  which  indicates  the  transformer 
capacity  necessary  to  serve  a  given  kind  of  connected  load.  Next  is 
the  diversity  between  different  kinds  of  load  whose  maximum  de- 
mands occur  at  different  times.  If  the  system  is  direct  current,  of 
course  the  transformers  are  omitted  and  the  diversity  factor  must 
be  taken  from  the  consumers'  services  to  the  ends  of  the  feeders 
supplying  the  various  mains. 

This  subject  has  not  been  studied  enough  so  that  many  figures 
cannot  be  given  on  the  demand  and  diversity  factors  of  various 
classes  of  service  and  the  diversity  factor  between  these  classes.  A 
compilation  of  some  of  the  available  figures,  however,  will  be  given 
in  the  hope  of  stimulating  further  interest  in  this  important  subject. 

Demand  Factors 

The  Wisconsin  Railroad  Commission  has  probably  carried  on  one 
of  the  most  comprehensive  series  of  investigations  yet  made  to  deter- 
mine this  demand  factor  or  ratio  of  maximum  demand  to  connected 
load  for  various  classes  of  consumers.  This  commission  in  the  case 
of  the  Ripon  Light  &  Water  Company  formulated  certain  rates. 
In  formulating  these  rates  it  was  necessary  to  assume  certain  figures 
for  demand  factors  of  various  consumers.  These  figures  as  fixed  by 
the  commission  were  based  on  data  from  a  large  number  of  other 
cities,  but  also  took  into  account  local  conditions.  These  figures 
were  as  shown  in  Table  I: 


DEMAND  AND  DIVERSITY  FACTORS  107 

TABLE  I 

Demand  Factors  Assumed  as  Basis  of  Ripon  Rates  by  Wisconsin 

Commission  in  Per  Cent 


Residences,  flat  and  rooming  houses. . 40 

Public  buildings 40 

Ripon  College 20 

Schools  and  churches 55 

Factories 55 

Hotels , 60 

Livery  stables 60 

Libraries 60 

Stores 75 

Offices 75 

Banks '. : 75 

Saloons 75 

Depots 75 

Theaters 75 

Club  rooms 75 

Electric  signs 100 

Hallways. .    100 

Street  lamps 100 

The  same  commission,  when  fixing  the  rates  for  Madison,  by 
decision  rendered  March  8,  1910,  specified  that  in  figuring  rates  for 
Madison,  the  following  demand  factors  should  be  used,  as  shown  in 
Table  II: 

TABLE  II 

Demand  Factors  Assumed   by  Wisconsin  Commission  for  Fixing 

Rate  at  Madison  in  Per  Cent 


Residence  lighting,  first  10  lamps 60 

Residence  lighting  over  10  lamps  or  500  watts 33.3 

Stores  and  offices 70 

Restaurants  and  saloon^*-,.«„ '. 70 

Lodge  and  dance  hall^ 70 

Laundries 70 

Depots 70 

Theaters 70 

Hall  lamps 70 

Factories 55 

Livery  stables 55 

Churches 55 

Hotels  and  clubs 55 

Schools 55 

County  and  federal  building 55 

University  of  Wisconsin 30 

Sign  and  outline  lighting 100 

One  motor  under  10  h.  p 90 

10  h.  p.  installation  with  more  than  one  motor 80 

Motor  installations  with  more  than  10  and  less  than  20  h.  p 70 

Motor  installations  20  to  50  h.  p 60 

Motor  installations  50  to  100  h.  p 55 

Motor  installations  100  h.  p.  or  over 50 


108  DEVELOPMENT  OF  SCIENTIFIC  RATES 

The  Wisconsin  commission  has  also  collected  data  from  a  number 
of  large  companies  using  Wright  demand  meters  by  which  it  is 
possible  to  know  the  actual  maximum  demand  of  each  consumer. 
The  demand  factors  obtained  from  these  companies  which  use 
maximum-demand  meters  vary  considerably,  as  will  be  seen  by 
Table  III,  which  gives  the  highest  and  lowest  figures  reported  for 
various  classes  of  business. 


TABLE  III 
Demand  Factors  Compiled  by  Wisconsin  Commission  from 
Companies  Using  Wright  Demand  Meters 


Stores 40  to  100 

Offices 57  to  87 

Saloons 62  to  92 

Restaurants 52  to  62 

Factories 53  to  56 

Churches 56  to  85 

Hotels 28 

Clubs 28 

Schools 37  to  52 

Laundries 60  to  75 

Livery  stables 52  to  58 

Lodge  and  dance  halls 68 

Depots 75  to  95 

Theaters 49  to  89 

Shops 55 

Machine  shops 37  to  54 

Blacksmith  shops 66 

County  and  federal  bldg 33  to  31 


The  Commonwealth  Edison  Company  of  Chicago  has  given  con- 
siderable study  to  this  matter  of  demand  factors,  and  many  figures 
covering  different  classes  of  consumers  can  be  found  in  two  papers 
presented  by  representatives  of  that  company  at  the  National 
Electric  Light  Association  conventions.  One  of  these,  entitled 
"Load  Factors,"  was  presented  by  Mr.  E.  W.  Lloyd  at  the  1909 
convention.  Another,  entitled  "Significance  of  Statistics,"  was 
presented  by  Messrs.  George  A.  McKana  and  B.  F.  McGuire  at  the 
1910  convention.  In  the  latter  paper  demand  factors  for  the  month 
of  January,  1910,  for  small  and  medium  lighting  customers  sum- 
marized were  as  shown  in  Table  IV: 


DEMAND  AND  DIVERSITY  FACTORS  109 

TABLE  IV 
Demand  Factors — Chicago  Lighting  Customers 

Offices  of  various  kinds 72 . 4 

Residences  and  barns 60 

Retail  stores , 66.3 

Wholesale  stores 70 . 1 

Billboards,  monuments  and  department  stores 85 . 6 

Average 59 . 8 

A  similar  table  was  given  for  the  motor  users  of  the  company  in 
the  direct-current  territory  where  Wright  demand  meters  are  used 
on  each  consumer's  service.  These  showed  demand  factors  as 
shown  in  Table  V : 

TABLE  V 
Demand  Factors — Chicago  Motor  Customers 

Public  gathering  places  and  hotels 28. 7 

Offices 65. 1 

Residences  and  bams 69 . 3 

Retail  stores 61.2 

Wholesale  houses  and  shops 58. 2 

Average 59 . 4 

The  average  of  59.4  per  cent  for  motor  customers  is  strikingly 
near  to  the  average  demand  factor  of  the  small  and  medium  size 
lighting  customers. 

In  the  paper  by  Mr.  Lloyd  before  referred  to,  figures  on  30,729 
residence  consumers  in  Chicago  show  the  following  percentages 
demand  factors: 

Residences  0 . 3  kw  connected  load 90 

Residences  0 . 5  kw  connected  load 64 

Residences  1  kw  connected  load 48 

Residences  2  kw  connected  load 46 


Diversity  Factors 

In  order  to  make  a  complete  study  of  diversity  factors,  it  is 
necessary  to  know:  first,  the  consumer's  connected  load;  second,  the 
maximum  demand  of  the  consumer  at  his  service  or  meter;  third,  the 
maximum  demand  which  he  places  on  the  transformer  or  direct- 
current  feeder  supplying  him  at  the  time  of  the  maximum  demand 


110  DEVELOPMENT  OF  SCIENTIFIC  RATES 

on  that  transformer;  fourth,  the  maximum  demand  which  he  causes 
on  the  feeder  supplying  him  at  the  time  of  maximum  demand  on  the 
feeder;  fifth,  if  the  system  is  a  large  one  employing  substations,  the 
maximum  demand  placed  by  the  consumer  on  the  substation  at  the 
time  of  the  substation  peak  load;  sixth,  maximum  demand  of  the 
consumer  at  the  time  of  the  generating-station  peak  load.  The 
reason  for  studying  the  maximum  demand  at  the  time  of  the  peak 
load  at  the  various  points  named  is  obviously  to  determine  the  in- 
vestment which  must  be  made  in  the  various  kinds  of  apparatus  to 
serve  a  given  consumer.  For  example,  it  is  the  simultaneous  de- 
mands of  a  number  of  consumers  which  determine  the  size  of  trans- 
former necessary  to  serve  that  group  of  consumers. 

The  most  complete  study  of  diversity  factor  which  has  been  made 
public  is  contained  in  a  paper  by  Mr.  H.  B.  Gear,  of  the  Common- 
wealth Edison  Company  of  Chicago,  presented  before  the  Western 
Society  of  Engineers  and  the  Chicago  Section  A.  I.  E.  E.,  March  23, 
1910.  Mr.  Gear  carried  his  analysis  as  far  back  as  the  substation 
busbars.  By  combining  the  diversity  factors  given  by  Mr.  Gear  in 
this  paper  with  the  demand  factors  of  residence  consumers  given  by 
Mr.  Lloyd  in  the  paper  already  referred  to,  some  instructive  figures 
are  obtainable,  as  follows: 

A  connected  load  in  Chicago  consisting  of  100  kw  in  residence 
consumers,  each  of  0.3  kw  connected  load,  will  cause  a  maximum 
demand  at  consumer's  meters  of  90  kw,  a  maximum  demand  at  the 
transformers  of  30  kw;  a  maximum  demand  at  the  feeder  panel  of 
16.6  kw,  and  a  maximum  demand  at  the  time  of  the  substation  peak 
of  14.5  kw. 

For  100  kw  connected  residence  load,  consisting  of  0.5  kw  con- 
sumers, demands  at  meters  would  total  64  kw;  transformers  21  kw; 
feeders  11.6  kw,  and  substations  10  kw. 

For  a  connected  residence  load  consisting  of  100  kw  in  con- 
sumers having  1  kw  connected,  each,  a  total  connected  load  of 
100  kw  would  cause  demands  as  follows:  Meters,  48  kw;  trans- 
formers, 16  kw;  feeders,  8.9  kw;  substations,  7.7  kw. 

For  a  group  of  residence  consumers,  each  of  2-kw  connected 
capacity,  the  demand  would  be  as  follows:  At  meters,  46  kw; 
transformers,  15  kw;  feeders,  8.3  kw;  substation  capacity,  7.2  kw. 

For  motor  load,  Mr.  Lloyd's  paper  before  referred  to  states  that 
the  ratio  of  average  to  connected  load  for  the  entire  number  of 
motor  customers  was  53.5  per  cent.     With  this  figure  as  a  basis. 


DEMAND  AND  DIVERSITY  FACTORS  111 

and  using  the  diversity  factors  for  scattered  motor  load  given  by 
Mr.  Gear,  a  connected  load  of  100  kw  in  motors  in  Chicago  would 
make  the  following  demands:  At  meters,  53.5  kw;  transformers, 
48.5  kw;  feeders,  24.2  kw;  substation  capacity,  21  kw. 

Taking  the  demand  figures  already  quoted  of  66.3  per  cent  for 
retail  stores  in  Chicago,  and  assuming  that  these  figures  can  be 
safely  applied  in  connection  with  the  diversity  figures  given  by  Mr. 
Gear  for  commercial  lighting,  the  following  demand  for  a  connected 
load  of  100  kw  would  obtain:  Demand  at  meter,  66.3  kw;  at  trans- 
former, 39.4  kw;  at  feeder  panel,  33.2  kw;  at  substation  peak,  28.8  kw. 

In  all  of  the  figures  so  far  given  on  Chicago  conditions  it  will  be 
noted  that  the  analysis  is  carried  back  only  as  far  as  the  substation. 
The  relations  between  the  different  kinds  of  load  and  the  peak  load 
on  the  main  generating  station  have  not  been  shown.  This  diversity 
between  different  kinds  of  business  is  very  important  in  its  influence 
on  the  generating  capacity  required.  The  following  figures  were 
obtained  from  some  typical  local  curves  of  the  Chicago  system. 

A  typical  three-phase  motor  circuit  daily  load  curve  in  December 
showed  that  58  per  cent  of  the  maximum  load  on  that  feeder  oc- 
curred at  5  p.  m.,  which  time  is  approximately  the  time  of  the  peak 
on  the  whole  system.  If  this  curve  is  a  fair  average,  therefore,  the 
maximum  meter  demand  of  such  a  motor  feeder  should  be  multiplied 
by  58  per  cent  to  get  the  demand  caused  on  the  system  at  the  time 
of  the  system  peak  load.  This  would  give  by  deduction  from  pre- 
vious motor  circuit  figures  a  station  peak  of  12.2  kw  for  each  100  kw 
connected  motor  load. 

A  typical  residence  circuit  daily  load  curve  for  December, 
published  at  the  same  time,  showed  that  75  per  cent  of  the  maximum 
load  was  on  at  5  p.  m.  The  maximum  load  on  that  feeder  occurred 
just  before  8  p.  m.  Applying  this  figure  of  75  per  cent  to  the  figures 
already  quoted  on  Chicago  residence  load  diversity  factor,  there 
would  be  a  maximum  demand  on  the  station  for  each  100  kw  con- 
nected for  various  classes  of  residence  load  as  follows:  Small 
residences,  0.3  kw  each,  10  kw  station  demand  for  each  100  kw 
connected;  residences  of  0.5  class,  7.5  kw  station  demand;  residence 
of  1  kw  class,  5.8  kw  station  demand;  residences  of  2  kw  class,  5.4  kw 
station  demand. 

The  commercial  lighting  load  in  Chicago  at  the  time  of  max- 
imum demand  is  so  different  in  different  districts  of  the  city  that  no 
general  conclusions  can  be  drawn. 


112  DEVELOPMENT  OF  SCIENTIFIC  RATES 

At  Detroit,  Mich.,  according  to  figures  published  at  various 
times  regarding  residence  Hghting  conditions  there,  it  appears  that 
for  a  connected  load  of  100  kw,  consisting  of  a  large  number  of 
residence  consumers  per  block,  the  maximum  demand  on  the  trans- 
formers would  be  20  kw;  that  on  the  substation  supplying  that 
district  14.3  kw;  and  that  on  the  power  station  at  the  time  of  the 
system  peak  7.1  kw.  From  the  last  two  figures  it  is  apparent 
that  at  the  time  of  the  peak  load  on  the  system,  only  50  per  cent  of 
the  residence  lighting  load  is  on.  The  remaining  50  per  cent  comes 
on  later,  subsequent  to  the  peak  on  the  system. 

At  Madison,  Wis.,  the  load  curves  published  in  connection  with 
the  commission's  decision  already  referred  to  indicate  that  for  a 
connected  motor  load  of  100  kw,  direct  current,  the  maximum 
demand  is  26  kw,  of  which  16  kw  occurs  at  the  time  of  the  station 
maximum  peak.  For  alternating-current  residence  lighting  in 
Madison  a  connected  load  of  100  kw  is  estimated  to  cause  50-kw 
maximum  demand  at  the  meters,  and  from  15  kw  to  20  kw  at  the 
transformers.  Alternating-current  commercial  lighting  at  Madison 
for  each  100  kw  connected  will  cause  50  kw  to  55  kw  maximum  de- 
mand at  the  transformers.  Taking  alternating-current,  commercial 
and  residence  lighting  together  in  Madison,  100  kw  connected 
causes  about  30  kw  maximum  demand  at  time  of  station  peak. 

At  Spokane,  Wash.,  analysis  of  the  load  on  a  residence  feeder 
shows  that  for  100  kw  connected  load,  the  maximum  demand  on 
that  residence  feeder  would  be  37  kw. 

At  Paxton,  111.,  100  kw  connected  load  in  direct-current  motors 
causes  a  maximum  demand  on  that  power  circuit  of  26  kw,  and  a 
maximum  demand  at  the  time  of  the  station  peak  in  December 
of  6.5  kw. 

In  small  towns  the  business  of  a  central  station  can  be  mainly 
classified  under  three  general  headings :  Motor  service,  residence 
service  and  business  district  lighting  service.  Conditions  vary 
widely  as  to  how  much  these  three  services  overlap  at  the  time  of 
the  station  peak  in  December.  In  some  towns  it  is  probable  that 
the  motor  load  is  almost  entirely  off  at  the  time  of  the  main  peak 
load  on  the  system.  On  the  other,  hand,  residence  lighting  is  very 
likely  to  overlap  the  main  peak,  because  of  the  custom  of  keeping 
stores  open  certain  nights  each  week  in  the  smaller  towns.  So  few 
small  companies  have  residence  and  business  lighting  feeders  sep- 


DEMAND  AND  DIVERSITY  FACTORS  113 

arated  that  information  on  this  matter  is  scarce.  Load  curves  from 
one  residence  and  one  commercial  lighting  feeder  of  the  Wabash 
(Ind.)  Water  &  Light  Company  for  Jan.  3  showed  the  same  value 
of  combined  residence  and  commercial  peaks  at  5  p.  m.  and  6  p.  m., 
but  the  elements  making  up  the  peak  were  different.  At  5  p.  m. 
the  residence  load  was  35  per  cent  of  the  combined  residence  and 
commercial  load,  while  at  6  p.  m.  the  residence  load  was  44  per  cent. 
The  figures  which  have  been  given  on  maximum  demand  on 
the  power  station  caused  by  a  given  amount  of  connected  residence 
load  show  why  it  is  that  some  central  stations  have  added  a  large 
number  of  residence  consumers  without  increasing  the  peak  load 
demand  much. 

Application  of  These  Factors  to  Rate  Making 

In  the  application  of  these  diversity  and  demand  factors  to  the 
fixing  of  rates  it  is,  of  course,  necessary  to  know  approximately  the 
investment  which  the  central  station  must  make  in  different  parts 
of  its  system  under  existing  local  conditions.  In  order  to  show  the 
method  of  working  out  the  investment  required  for  a  given  class  of 
consumers  per  kw  of  connected  load,  assume  a  hypothetical  case  of 
a  residence  consumer  whose  connected  load  is  0.5  kw. 

Taking  this  consumer's  connected  load  as  100  per  cent,  assume 
that  the  following  demand  and  diversity  factors  have  been  found 
to  apply  to  the  local  conditions  under  consideration:  Connected 
load,  100  per  cent;  maximum  demand  at  meter,  60  per  cent  of 
connected  load;  maximum  demand  at  transformer,  25  per  cent  of 
connected  load;  maximum  demand  on  feeder,  12  per  cent  of  con- 
nected load;  maximum  demand  on  generating  station  at  time  of 
station  peak,  10  per  cent  of  connected  load. 

As  to  investments,  assume  meters  at  $12  each;  transformer  at 
$10  per  kw  of  capacity;  overhead  lines  at  $50  per  kw  of  maximum 
feeder  demand,  and  power  station  at  $100  per  kw  of  maximum  de- 
mand. For  each  0.5  kw  consumer  there  would  then  be  the  following 
investment:  One  meter  at  $12;  transformer  capacity,  $10  X  25 
per  cent  X  0.5  kw,  or  $1.25;  fines,  $50  X  12  per  cent  X  0.5  kw,  $3; 
station  capacity,  $100  X  10  per  cent  X  0.5  kw,  $5;  investment  for 
each  0.5  kw  consumer,  $21.25;  investment  per  kw  connected  of  such 
consumers,  $42.50.  The  foregoing  figures  begin  at  the  consumer 
end  and  go  back  to  the  station.  It  is  possible  to  calculate  the 
investment  beginning  at  the  station  end,  but  it  is  usually  most 
convenient  to  figure  from  the  consumer's  end. 


Effect  of  Width  of  Maximum 
Demand  on  Rate  Making 

by 
LOUIS  A.  FERGUSON 


Presented  before 

Association  of  Edison  Illuminating  Companies 

September  1911 


(Reprinted  from  Proceedings  Association  of  Edison  Illuminating 
Companies,  September  1911,  pp.  159-165) 


INDEX 

Page 

Introduction 117 

Load  Factor 117 

Methods  of  Determining  Maximum  Demand.. 118 

Variation  in  Demand  Intervals 119 

Penalty  for  Poor  Power  Factor 119 

Relative  Advantages  of  Short  and  Long  Demand  Intervals  120 

Relation    Between    One-Hour    Peak    and    Various    Shorter 

Peaks 122 

Effect  of  Demand  Interval  on  Rates 123 

Demand  Intervals  Used  by  Various  Companies 124 

Arguments  in  Favor  of  Thirty  Minute  Interval 124 

Conclusion 125 


Effect  of  Width  of  Maximum  Demand  on 
Rate  Making 

By  Louis  A.  Ferguson 

1911 
Introduction 

The  possibility  of  the  large  prospective  consumer  installing  his 
own  isolated  plant  does  not  seem  to  completely  down,  and  it  is, 
therefore,  highly  important  that  schedules  for  the  supply  of  large 
business  should  be  carefully  prepared  to  meet  competitive  condi- 
tions which  are  being  continually  presented.  These  schedules 
should  take  into  consideration  the  hour's  use  or  load  factor  of  the 
business,  as  most  of  us  appreciate,  otherwise  the  Central  Station 
will  obtain  the  unprofitable  short-hour  business  and  lose  that  most 
to  be  desired  long-hour  profitable  business. 

The  wholesale  rate  schedule  should  differentiate  as  to  quantity, 
load  factor,  power  factor  where  practicable,  and  even  as  to  the  kind 
of  supply,  whether  alternating  or  direct  current  or  whether  high  or 
low  tension,  and  because  of  the  comparatively  small  number  of  such 
consumers  and  their  large  size,  it  is  permissible  that  the  schedule  be 
somewhat  more  complicated  than  the  retail  schedule. 

This  paper  will  deal  more  particularly  with  the  subject  of  the 
proper  method  of  measuring  the  maximum  demand  from  which  the 
load  factor  of  these  larger  or  wholesale  consumers  is  determined. 

Load  Factor 

Until  very  recently  there  has  been  much  confusion  in  regard  to 
the  term  "Load  Factor."  Even  today,  after  years  of  discussion, 
and  with  a  fairly  good  general  understanding  of  the  authoritative 
definition  of  load  factor  there  is  still  much  uncertainty  unless  ex- 
planatory statements  are  added.  Load  factor  is  based  on  two  quan- 
tities: (a)  The  average  kilowatt  hours  per  hour  consumed  or  gen- 
erated in  a  given  number  of  consecutive  hours,  as,  for  instance,  in 
a  10-hour  day,  a  24-hour  day,  a  month  or  a  year;  and  (b)  the  maxi- 
mum demand  during  the  corresponding  period. 

It  is  now  more  generally  appreciated  that  in  rate  making  at 
least  the  yearly  load  factor  is  the  only  proper  one  to  consider  be- 


118  DEVELOPMENT  OF  SCIENTIFIC  RATES 

cause  fixed  charges  on  investment  are  usually  the  most  important 
items  of  cost  and  these  fixed  charges  continue  every  hour  in  the 
entire  year.  The  yearly  load  factor  is  for  this  reason  coming  into 
general  use  and  in  the  absence  of  any  qualifying  statement  the 
yearly  load  factor  would  be  understood. 

Methods  of  Determining  Maximum  Demand 

The  exact  meaning  of  maximum  demand  or  the  second  quantity, 
(b),  would  not  be  generally  understood  if  not  specified,  especially  in 
connection  with  the  sale  of  alternating  current  energy.  As  pointed 
out  at  last  year's  convention  by  Mr.  R.  S.  Hale  in  his  paper  on 
"•Measuring  Demand,"  several  methods  are  in  use  for  determining 
the  maximum  demand.  These  are:  First,  The  so-called  "non- 
instrumental  methods,"  which  should  apply  to  all  small  lighting 
consumers;  and,  second,  the  "instrumental  methods"  which  should 
be  applied  to  all  large  consumers. 

Small  consumers  in  this  statement  refer  to  those  having  a  maxi- 
mum demand  not  exceeding  one  or  possibly  two  kilowatts  and 
which,  therefore,  include  95  per  cent  or  more  of  the  residential  con- 
sumers in  a  large  city.  Large  consumers  in  the  foregoing  statement 
refer  to  those  having  a  maximum  demand  in  excess  of  30  or  40  kilo- 
watts. In  the  latter  case,  the  actual  demand  is  by  far  the  most 
important  factor  in  the  cost  of  supplying  such  consumer  and  must, 
therefore,  be  determined  accurately  and  continuously. 

The  principal  methods  are  as  follows:  (1)  The  momentary  swings 
of  an  indicating  or  graphic  recording  instrument;  (2)  the  current 
required  to  produce  a  given  heating  effect,  as  in  a  Wright  demand 
indicator;  (3)  the  watt-hour  consumption  or  integrated  demand  dur- 
ing a  specified  interval  of  time,  as  one  minute,  five  minutes,  fifteen 
minutes,  half  hour  or  one  hour.  The  last  mentioned  method  is  now 
being  used  almost  exclusively  in  the  measurement  of  alternating 
current  energy,  but  there  is  still  a  great  divergence  of  practice  as 
to  the  interval  of  time  and  also  as  to  whether  the  maximum  demand 
charge  is  based  on  the  highest  individual  peak  or  on  an  average  of 
several  peaks,  and  if  so,  how  many. 

This  is  extremely  unfortunate  and  often  puts  the  Central  Sta- 
tion Company  at  a  disadvantage,  especially  when  dealing  with  large 
consumers  or  allied  industries  who  operate  in  several  cities  and  in 
which  cities  the  prevailing  practice  as  to  interval  taken  in  deter- 


EFFECT  OF  WIDTH  OF  MAXIMUM  DEMAND      119 

mining  maximum  demand  may  be  very  difJerent.  The  following 
will,  therefore,  be  confined  largely  to  a  consideration  of  most  desir- 
able intervals. 

Variation  in  Demand  Intervals 

The  Wright  demand  indicator  installation  used  by  several  of  the 
large  companies  answers  very  well  for  direct  current  installations 
of  moderate  size,  but  is  found  rather  expensive  for  very  large  D.  C. 
installations  and  unsatisfactory  for  alternating  current  because  of 
the  large  rushes  of  current  in  the  starting  of  A.  C.  motors.  In 
direct  current  installations,  for  instance,  the  Wright  demand  indi- 
cators will,  under  most  conditions,  indicate  about  85  per  cent  of  the 
maximum  in  5  minutes  and  the  full  maximum  in  30  minutes.  As- 
this  indicator  has  found  rather  wide  application  in  several  cities^ 
the  interval  (one-half  hour  with  a  steady  load)  required  to  show^ 
the  full  maximum  on  this  instrument  naturally  had  some  influence 
in  fixing  the  width  of  peak  over  which  the  maximum  was  integrated 
in  the  sale  of  alternating  current  power. 

It  must  be  borne  in  mind  that  with  a  steady  load  there  is  no 
difference  between  a  o-minute  and  a  one-hour  peak.  If  the  load  is 
intermittent,  the  shorter  interval  will  give  the  higher  maximum 
demand.  In  making  a  schedule  of  rates  for  large  consumers  it  is 
necessary,  therefore,  if  the  rate  is  to  be  a  just  one  for  all  the  users  in 
a  given  class,  that  a  fixed  interval  for  maximum  demand  be  estab- 
lished; that  is,  either  the  instantaneous,  the  one  minute,  the  five 
minute,  quarter  hour,  half  hour,  or  the  one  hour. 

If  the  entire  output  of  a  water  power  plant  with  long  transmis- 
sion lines  is  taken  by  a  very  few  consumers,  each  taking  large  blocks 
of  power,  a  short  interval  might  be  preferable. 

Penalty  for  Poor  Power  Factor 

In  such  cases  it  is  also  sometimes  desirable  to  increase  the 
charge  to  the  consumer  if  the  power  factor  of  his  load  falls  below 
a  reasonable  figure. 

In  such  portions  of  our  large  cities,  however,  as  are  supplied  by 
alternating  current  energy  the  maximum  load  almost  invariably 
occurs  between  six  and  nine  o'clock  when  it  is  almost  exclusively 
lighting,  and  as  a  result  the  power  factor  is  high  at  that  time  in  the 
evening.  The  day  load  or  motor  load  in  above  mentioned  portions 
of  these  cities  which  naturally  has  a  poor  power  factor  is  usually  less 


120  DEVELOPMENT  OF  SCIENTIFIC  RATES 

than  one-half  the  evening  load.  The  amount  of  copper  in  the  dis- 
tribution system  is  therefore  not  injuriously  affected  by  the  poor 
load  factor  in  the  daytime,  and  hence  the  cost  to  the  central  station 
company  is  not  appreciably  affected.  Moreover,  rotary  condensers 
may  be  used  in  such  particular  sub-stations  where  the  power  factor  is 
lower  than  desirable,  thus  insuring  a  high  power  factor  on  the  gen- 
erators, transmission  lines  and  sub-stations,  and  then  in  the  worst 
event  only  the  distribution  system  would  be  affected.  In  dealing 
with  large  number  of  power  consumers  it  is  diflBcult  enough  to  have 
them  understand  load  factor,  to  say  nothing  of  such  a  complicated 
matter  as  an  equitable  charge  for  low  power  factor.  For  these  rea- 
sons the  Central  Station  companies  operating  in  large  cities  prac- 
tically always  charge  for  the  maximum  demand  on  the  basis  of  true 
energy  or  watt-hour  consumption  and  will  also  find  many  advan- 
tages in  using  a  reasonably  long  interval. 

Relative  Advantages  of  Short  and  Long  Demand  Intervals 

In  order  to  separate  more  easily  the  relative  advantages  of  short 
and  long  intervals  in  obtaining  the  maximum  demand,  it  is  well  to 
consider  a  simple  example — the  sight  reading  of  the  dial  of  ordinary 
watt-hour  meter  by  an  observer.  There  are  immediately  apparent 
two  causes  of  error:  (1)  the  time  of  observation  of  the  length  of 
interval,  and,  (2)  the  value  of  the  reading.  Suppose  the  operator  is 
allowed  a  leeway  of  ten  seconds  on  either  side  of  the  exact  time. 
The  maximum  error  in  five  minutes  would  be  approximately  6  per 
cent,  while  in  one  hour  it  would  be  less  than  6-10  of  1  per  cent.  In 
the  second  place,  assume  that  the  meter  has  a  constant  of  1,  is  read 
directly  in  K.  W.  H.  and  is  installed  on  a  line  using  about  1  K.  W.  H. 
per  minute.  If  the  observer  is  allowed  to  interpolate  to  one-quarter 
of  each  division  then  there  is  a  maximum  possible  error  of  3^ 
K.  W.  H.  In  five  minutes  this  would  introduce  an  error  of  5  per  cent, 
but  in  one  hour  only  4-10  of  1  per  cent.  The  above  illustration 
assumes  a  meter  constant  of  one,  and  the  percentage  of  error  given 
should  be  increased  correspondingly  by  the  larger  constant  always 
necessary  for  a  large  consumer. 

Another  illustration  of  the  advantage  of  using  longer  intervals 
is  an  actual  case  in  which  power  was  sold  to  a  large  street  railway 
system  and  metered  on  a  number  of  transmission  lines  each  deliver- 
ing a  coincident  maximum  demand  of  about  1800  kw.  Originally 
one  division  of  the  lowest  dial  of  the  meter  multiplied  by  the  con- 
stant of  the   meter   best  fitted  for   the  purpose  which  was  on  the 


EFFECT  OF  WIDTH  OF  MAXIMUM  DEMAND      121 

market  at  that  time  was  something  Hke  400  kw.  This  meant  a 
maximum  possible  error  of,  say,  400  kw.,  which  would  have  been 
prohibitive  except  that  there  were  several  lines  used  in  the  supply 
and  also  the  average  of  several  maxima  was  used.  But  even  then 
the  results  were,  of  course,  not  satisfactory. 

On  the  meters  now  in  use  by  the  same  company  on  the  very 
large  number  of  railway  lines  delivering  an  aggregate  of  over  100,000 
kilowatts  one  division  of  the  first  dial  amounts  to  1-100  kw.,  which, 
multiplied  by  the  constant  which  is  usually  4000,  gives  the  value  of 
the  lowest  division  of  the  dial  as  40  kw.  The  hourly  reading  is  40 
kw.  divided  by  1800  kw.  (the  output  for  one  hour)  or  a  maximum 
possible  error  of  2.2  per  cent.  With  a  half-hour  interval  the  error 
is  the  same,  but  the  percentage  is  double — 40  kw.  divided  by  900 
kw.,  or  4.4  per  cent.  Similarly  the  quarter-hour  error  w^ould  be  8.8 
per  cent  and  the  five-minute  error  26.6  per  cent. 

In  the  railway  business  cited,  hourly  intervals  are  used  and  this 
possible  error  is  reduced  by  using  the  average  of  several  maxima. 
The  maximum  error  of  each  hourly  reading  is  2.2  per  cent.  Taking 
the  average  of  several  cases,  the  error,  according  to  the  law  of 
averages,  would  be  only  one-half  of  this,  or  1.1  per  cent,  and  the 
more  we  can  average  within  practical  limits  the  more  this  percentage 
of  error  will  be  reduced.  For  instance,  using  the  average  of  six 
peaks  would  theoretically  reduce  the  error  of  2.2  per  cent  to  .37  of 
1  per  cent. 

The  error  in  reading  any  integrating  meter  used  in  determining 
the  maximum  demand  (and  this  error  as  shown  above  may  be  very 
large)  would  be  a  much  smaller  percentage  of  the  total  energy  for  a 
long  period  than  for  a  short  one;  in  fact,  the  error  is  inversely  pro- 
portional to  the  interval. 

Where  more  than  one  instrument  is  required  to  determine  a  par- 
ticular customer's  peak  load  the  labor  involved  in  computing  the 
maximum  is  quite  an  item,  as  the  output  of  all  the  meters  for  the 
intervals  on  which  the  contract  is  based  must  be  added  together  to 
obtain  the  coincident  maximum  demand.  If  a  o-minute  interval 
were  used,  the  labor  in  computing  the  maximum  would  be  practically 
12  times  as  great  as  for  the  one  hour.  The  longer  interval  is,  of 
course,  more  favorable  to  the  consumer  with  the  intermittent  load, 
as  it  does  not  penalize  him  for  the  short  peaks.  This  feature  ap- 
peals to  the  consumer  as  the  primary  or  maximum  demand  charge  is 


122  DEVELOPMENT  OF  SCIENTIFIC  RATES 

usually  the  least  intelligible  to  him,  and  the  shorter  the  interval, 
the  harder  it  is  for  him  to  understand.  He  realizes  that  the  total 
kilowatt  hours  used  bear  some  direct  relation,  to  the  amount  of 
work  done,  but  the  maximum  demand,  particularly  if  it  be  an 
instantaneous  or  very  short  interval  demand,  is  not  so  well  under- 
stood. 

Relation  Between  One- Hour  Peak  and  Various  Shorter  Peaks 

In  order  to  determine  the  relation  between  the  one  hour  peak  and 
the  various  shorter  peaks  some  accurate  observations,  most  of  them 
very  recent,  were  made  on  different  classes  of  consumers,  all  but  one 
of  which  are  in  or  near  Chicago,  and  are  given  in  Table  I : 


TABLE  I 

Per  cent 

of  one  hour  maximum 

30  min.  15  min.  .5  min. 

(1)  Large  street  railway  system 101.6        104.8        110. 

(2)  Electrical  steam  railway  terminal 117.  .... 

(3)  Interurban  railway 109.  119.  126. 

(4)  Large  hotel 107.  107 

(5)  Large  department  store 101.5        103.  110.5 

(6)  Government  building  (large) 103.  104.5       109. 

(7)  Piano  factory  (average  size) 102. 5        107.  113. 

(8)  Grain  elevator  (average  size) 109.  113.  118. 

(9)  Large  stone  quarry 101.8       106.  112. 

(10)  Small  stone  quarry 105.  117.  128. 

(11)  12-story  office  building 109.  113.  133. 

(12)  19-story  office  building 108.  108.  138. 

-  In  the  two  office  buildings  the  maximum  demands  under  each 
of  the  three  different  intervals  include  only  the  elevator  and  general 
power  and  do  not  include  any  of  the  lighting.  An  inspection  of 
this  five-minute  power  load  curve  indicates  that  four  extraordinary 
peaks  at  9:20,  9:40,  12:40  and  3:50  caused  the  large  percentage  of 
difference  between  the  5-minute  and  the  30-minute  peak  on  the 
19-story  office  building.  Similarly  one  very  unusual  peak  at  8:30 
A.  M.  occurred  on  the  12-story  office  building. 

An  analysis  of  the  data  on  the  large  department  store  given  in 
Table  I  indicates  that  if  the  bills  for  a  year  had  been  rendered  on  a 
5-minute  peak  the  maximum  demand  on  primary  charge  would  have 
been  8.1   per  cent  greater  than  on  the  30-minute  peak  actually 


EFFECT  OF  WIDTH  OF  MAXIMUM  DEMAND      123 

billed,  but  the  total  bills  for  the  year  would  have  been  only  3  per 
cent  greater  on  the  5-minute  than  on  the  30-minute  peak. 

The  difference  between  the  5-minute  and  30-minute  peak  on  the 
piano  factory  would  have  been  9  per  cent  in  primary  charge  but 
only  3.8  per  cent  in  the  total  charge.  On  the  grain  elevator  the 
difference  would  have  been  7.7  per  cent  in  primary  and  3.9  per  cent 
in  total  charge. 

Effect  of  Demand  Interval  on  Rates 

While  none  of  the  differences  in  the  three  cases  analyzed  or  in 
most  of  those  given  in  Table  I  are  very  large  they  show  conclu- 
sively that  the  width  of  peak  should  always  be  taken  into  account  in 
establishing  rates  for  electric  service.  In  other  words,  broadening 
the  peak  is  equivalent  to  lowering  the  price. 

The  actual  result  on  price  of  a  given  broadening  of  peak  depends 
— First,  on  the  amount  of  broadening,  that  is,  from  say  5  minutes  to 
30  minutes,  and,  secondly,  on  the  steadiness  or  unsteadiness  of  load. 

The  percentage  difference  in  total  income  between  the  results 
obtained  from  5-minute  and  30-minute  intervals  is  relatively  small 
and  it  is  much  better  to  take  care  of  a  small  difference  of  this  kind 
by  a  slight  adjustment  in  making  the  original  primary  rates  than 
to  have  any  possibility  of  the  most  important  customers  feeling  that 
the  method  used  is  not  accurate  enough  and  not  fair  to  them  in  all 
cases.  As  an  illustration,  assume  that  there  is  5  per  cent  difference 
in  total  bill  between  the  5-minute  and  the  30-minute  method.  The 
power  company  should  not  feel  that  it  is  giving  away  this  difference 
by  using  the  30-minute  readings.  In  making  up  a  schedule  of  rates 
this  5  per  cent  should  be  taken  into  consideration  by  making  the 
primary  enough  higher  to  compensate  for  this  difference. 

Some  consideration  of  the  size  of  the  consumer  and  the'  question 
of  diversity  factor  will  be  worth  while  in  a  study  of  the  relative 
merits  of  long  and  short  intervals,  and  as  to  whether  to  use  one 
reading  or  the  average  of  several  readings.  With  either  lighting  or 
power,  but  especially  with  power,  the  more  intermittent  the  load 
and  the  smaller  the  consumer,  the  greater  will  be  the  diversity 
factor. 


124  DEVELOPMENT  OF  SCIENTIFIC  RATES 

Demand  Intervals  Used  by  Various  Companies 

In  order  to  ascertain  the  present  practice  and  apparent  tendency 
in  this  matter,  information  was  secured  from  the  companies  oper- 
ating in  the  larger  cities  and  which  is  given  in  Table  II : 

TABLE  II 

Width  of  Peak  Used  in  Different  Cities  in   Determining 
Maximum  Demand  Charge 

General  Light 
and  power 

Buffalo,  New  York 2  Min. 

*Spokane,  Washington 

New  York,  New  York 5  to  10  Min. 

Cleveland,  Ohio 15     " 

Los  Angeles,  California 15     " 

Milwaukee,  Wisconsin 15     " 

*Minneapolis,  Minnesota 15     " 

*Rochester,  New  York 15     " 

St.  Louis,  Missouri 15     " 

*Boston,  Massachusetts 30     " 

♦Brooklyn,  New  York 30     " 

♦Chicago,  Illinois 30     " 

Kansas  City,  Missouri 30     " 

Detroit,  Michigan 60     " 

Philadelphia,  Pennsylvania 

The  member  companies  in  cities  marked  thus  *  use  Wright  de- 
mand indicators  for  part  or  all  of  their  D.  C.  consumers,  but  not 
for  A.  C.  consumers.     Those  marked  thus   ........  in  one  or  the 

other  column  use  either  non-instrumental  methods  for  determining 
the  maximum  demand;  sell  on  a  straight  kilowatt  hour  basis;  or  else 
sell  no  power  for  railway  purposes  of  any  kind. 

In  some  cases  a  company  has  used  different  intervals  at  different 
times,  but  those  given  in  Table  II  are  those  reported  by  them  to  the 
writer  as  being  used  in  their  latest  contracts  for  power  or  wholesale 
light  and  power. 

Arguments  in  Favor  of  Thirty  Minute  Interval 

Only  two  of  the  companies  in  the  fifteen  of  the  larger  cities  of 
the  country  given  in  Table  II  use  an  interval  of  less  than  15  minutes 
for  general  light  and  power;  6  companies  use  15  minutes;  4  use  30 
minutes  and  1  uses  60  minutes.  The  writer  believes  that  for  the 
sale  of  general  light  power  an  interval  of  5  minutes  or  less  is  unwise; 
also  that  a  30-minute  interval  is  slightly  better  than  a  15-minute 
interval  and  summarizes  his  reasons  as  follows: 


Railway 

power 

5  Min. 

15  Min. 

30  Min. 

60     " 

60  Min. 

60     " 

60     " 

60     " 

EFFECT  OF  ^YIDTH  OF  MAXIMUM  DEMAND      125 

1 .  Short  interval  readings  either  introduce  greater  percentage  of 
error  in  the  maximum  demand  or  added  compHcations  and  difficulty 
in  metering. 

2.  Short  interval  readings  are  not  necessary  on  a  large  consu- 
mer, because  his  load  is  usually  made  up  of  large  number  of  units 
and  therefore  load  is  more  uniform,  or  to  express  it  differently,  the 
ratio  of  5  minutes  to  3^  hour  maxima  is  small. 

3.  The  existence  of  a  very  high  or  large  diversity  factor  be- 
tween the  small  consumers  and  also  between  the  consumers  who  use 
their  power  intermittently  reduces  the  necessity  for  a  short  interval 
maximum  for  these  small  or  medium  sized  consumers. 

4.  The  use  of  short  and  frequent  intervals  requires  much  more 
work  to  figure  and  is  no  inconsiderable  item  when  it  is  considered 
that  there  is  usually  a  subtraction  of  readings  in  one  form  or  another 
and  multiplication  by  a  constant. 

5.  The  practicability  of  off-setting  the  slight  apparent  conces- 
sion of  using  a  longer  interval  of  average  of  more  than  one  maximum 
by  a  slightly  higher  primary  rate  of  charge  per  kw  eliminates  the 
necessity  for  use  of  short  intervals. 

6.  The  use  of  a  long  interval,  say  30  minutes,  as  against  5 
minutes,  makes  only  a  very  slight  difference  in  income,  which  may 
easily  be  allowed  for  in  rate-making,  and  promotes  much  better 
relations  with  the  consumer  who  can  never  understand  why  he 
should  be  penalized  for  an  occasional  or  accidental  demand  which 
lasts  only  a  few  moments. 

Conclusion 

The  writer  desires  that  in  advocating  the  use  of  a  maximum  of 
moderate  length  with  a  compensated  primary  charge  his  position 
should  not  be  construed  as  relinquishing  the  advantage  to  the 
supply  company  of  the  diversity  factor  of  its  various  consumers,  but 
rather  the  opposite,  as  stated  in  a  former  paper,  in  which  he  has 
said : 

"The  diversity  factor  is  the  very  foundation  rock  of  centralized 
energy  supply.  It  is  the  birthright  of  the  Central  Station,  the 
fundamental  basis  of  its  existence  and  its  resultant  value  belongs 
to  the  Central  Station  Company." 


Reasonable  Profit 

Its  Definition,  Collection 
and  Distribution 

by 
JAMES  V.  OXTOBY 


Presented  before 

Association  of  Edison  Illuminating  Companies 

September,  1910 

And  Revised  to  October  31st,  1910 


(Reprinted  from  Legal  Phases  of  Central  Station  Rate  Making 

for  Electric  Supply,  Printed  by  Association  of 

Edison  Illuminating  Companies,  1911) 


INDEX 

Paragraphs 

Introduction 1-4 

Definition  of  Reasonable  Profit 5-39 

Collection  of  Profit  from  Classes  of  Customers 40-70 

Distribution  of  Profit  Between  Stocks  and  Bonds 71-90 

Conclusions 91 


INDEX  TO  APPENDIX 

Page 
Memorandum  of  Authorities  on  Reasonable  Profit 161 

Memorandum  of  Decisions  of  Railroad  Commission  of  Wis- 
consin         178 

Extract  from  Wilcox  vs.  Consolidated  Gas  Company,  212 

U.  S.  19 179 

Extracts  from  Recent  Decisions  of  Railroad  Commission  of 
Wisconsin,  on  Reasonable  Profit: 

(1)  Case  of  Menominee  &  Marinette  Light  and  Trac- 

tion Company  (August,  1909) 182 

(2)  Case  of  Antigo  Water  Company  (August,  1909)        184 

(3)  Case  of    Madison    Gas    and    Electric    Company 

(March,  1910) 194 

Decision  of  Massachusetts  Gas  and  Electric  Light  Commis- 
sion in  matter  of  gas  rates  of  Charlestown  Gas  and  Elec- 
tric Company 208 

Rule  of  New  York  Public  Service  Commission,  Second  Dis- 
trict, as  to  apportionment  of  capitalization  between 
bonds  and  stock 210 

Extract  from  decision  of  Massachusetts  Gas  and  Electric 
Light  Commission  in  matter  of  rates  of  Edison  Elec- 
tric Illuminating  Company  of  Boston 211 

Extract  from  address  of  Senator  Joseph  W\  Bailey,  on  "The 
Power  to  Regulate  Transportation  Charges  by  Statutory 
Enactment" 216 

Extracts  from  Testimony  of  Mr.  E.  P.  Ripley  before  Inter- 
state Commerce  Commission 221 

Summary  of  Testimony  of  Mr.  Jas.  McCrea  before  Inter- 
state Commerce  Commission 225 


Reasonable  Profit 

Its  Definition,  Collection  and  Distribution 

By  James  V.  Oxtoby 

1910 

Introduction 

It  is  the  purpose  of  this  paper  to  state  the  rules  estabUshed  by 
the  authorities  on  the  subject  of  the  reasonable  profit  which  public 
utilities  should  receive  in  the  course  of  their  operations.  Where  no 
rules  exist,  an  attempt  i;\dll  be  made  to  suggest  what  such  rules 
ought  to  be. 

1.  The  regulation  of  rates  for  public  services  has  assumed 
increased  importance  in  the  past  few  years.  Instead  of  an  occa- 
sional regulation  of  some  particular  public  service  by  a  State  Legis- 
lature or  a  local  legislative  body,  regulation  of  all  public  utilities 
has  been  undertaken  as  a  matter  of  general  pubHc  policy.  Commis- 
sions have  been  created  with  power  to  regulate  according  to  rules 
of  general  application.  While  local  legislative  bodies  should  be 
bound  by  the  same  rules  as  commissions,  it  is  hardly  to  be  expected 
that  any  well  defined  rules  have  or  will  be  developed  from  their 
conclusions. 

'-2.  The  courts  have  quite  generally  upheld  the  right  of  the 
legislatures  to  delegate  the  rate-making  power  to  commissions. 
These  commissions  must  necessarily  have  broad  discretionary 
powers,  and  it  is  to  them  that  we  must  look  for  the  declaration  and 
application  of  sound  principles. 

3.  The  subject  of  rate  regulation  is  of  such  complexity  that 
courts  and  commissions  have  gone  slowly  in  declaring  principles,  and 
applying  them  to  particular  facts.  The  proposition  that  rates  shall 
be  "reasonable  and  just"  is  not  new.  Statutory  provisions  to  this 
effect  are  but  declaratory  of  the  common  law.  The  commissions,  in 
the  first  instance,  must  determine  in  each  case  what  is  reasonable 
and  just  to  all  parties,  and  it  is  important  that  none  of  the  factors  in 
the  problem  be  overlooked.  It  is  desirable  that  correct  principles  of 
rate-making  be  defined  and  observed  by  these  bodies,  and  the  cor- 
rective power  of  the  courts  called  upon  as  little  as  possible.     Ques- 


130  DEVELOPMENT  OF  SCIENTIFIC  RATES 

tions  pertaining  to  rates  must  generally  come  before  the  commissions 
in  the  first  instance,  and  it  is  their  function  to  investigate,  define, 
and  apply  correct  economic  principles. 

4.  The  chief  elements  in  determining  a  reasonable  rate  for  any 
particular  public  service  are  (a)  the  fair  value  of  the  property  used 
in  serving  the  public,  (b)  the  reasonable  value  of  the  service  to  the 
public,  (c)  the  proper  deductions  to  be  made  for  expenses,  including 
depreciation  and  obsolescence,  and  (d)  the  reasonable  rate  of  profit 
or  return  to  be  allowed  on  the  value  of  the  property  used.  It  is  the 
purpose  of  this  paper  particularly  to  discuss  the  question  of  reason- 
able profit,  or  rate  of  return,  which  should  be  allowed  to  a  public 
service  corporation,  in  the  making  of  its  rates.  To  this  question 
are  closely  related  the  elements  of  value  of  the  property  used,  and 
the  value  of  the  service  rendered. 

I — Definition  of  Reasonable  Profit 

5.  Judge  Walter  C.  Noyes  in  his  book,  "American  Railroad 
Rates"  (September,  1905,  p.  28)  says,  "What  the  fair  return  is, 
which  a  railroad  is  entitled  to  receive,  cannot  be  determined  by  the 
application  of  any  fixed  standard.  It  must  vary  with  the  period 
and  with  the  conditions.  It  should  be  sufficient  and  only  sufficient 
to  lead  to  the  continued  investment  of  capital  in  railroads.  Rates 
should  be  so  adjusted  that  the  total  revenue  produced  by  them  will 
compensate  the  railroad,  to  the  extent  that  the  same  amount  of 
energy  expended  in  other  branches  of  productive  industry  is  com- 
pensated." 

6.  Professors  Beale  and  Wyman  in  their  work  on  "Railroad 
Rate  Regulation"  (July,  1906,  Sec.  312),  say,  in  discussing  the 
reasonableness  of  an  entire  schedule  of  railroad  rates:  "The  deter- 
mination of  the  actual  amount  of  the  capital  invested  may  be  a 
matter  of  some  difficulty.  Once  determined,  the  rate  of  profit  upon 
that  amount  of  capital  is  a  question  which  will  be  determined,  gen- 
erally speaking,  by  the  ordinary  business  profit  of  the  time  and 
place.  A  schedule  of  rates  will  be  reasonable  from  the  point  of  view 
of  the  carrier,  if  it  yields  him  a  net  profit  equal  to  that  which  would 
be  realized,  as  a  business  question,  from  any  other  business  where 
the  capital  and  the  risk  are  the  same." 

7.  In  giving  a  talk  to  employes  on  "Rates  and  Costs"  in 
March,  1907,  Mr.  Alex  Dow  gave  this  short  and  concise  definition: 
*'A  reasonable  profit  to  people  who  invest  their  money  in  any  busi- 


REASONABLE  PROFIT  131 

ness,  is  that  amount  of  profit  which  will  bring  to  the  business  freely 
the  amount  of  money  which  it  needs;  neither  more  than  that,  nor 
less  than  that." 

8.  The  Railroad  Commission  of  Wisconsin,  in  its  opinion  in 
the  case  of  the  Madison  Gas  &  Electric  Company,  (March  8,  1910, 
See  appendix),  says:  "The  rate  that  may  be  considered  a  reason- 
able return  for  interest  and  profits  on  the  investment,  undoubtedly 
varies  with  the  circumstances.  Generally  speaking,  however,  it  can 
perhaps  be  said  that  under  normal  conditions  it  consists  of  the 
ordinary  rates  for  capital  similarly  invested,  and  that  are  sufficiently 
high  to  encourage  investors  to  put  their  money  into  such  enter- 
prises." 

9.  The  editor  of  the  "Railway  Age  Gazette"  (issue  of  July  1, 
1910)  in  an  article,  "The  New  Epoch  of  Railway  Affairs,"  stated: 
"It  ought  to  be  plain  to  every  thinking  business  man  that  the  profits 
on  any  one  industry  cannot  be  arbitrarily  restricted,  while  the  profits 
of  other  concerns  are  not  limited,  without  inviting  diaster.  The 
public  can  perhaps  determine  what  returns  shall  be  earned  on  the 
present  investment  of  railways;  but  it  cannot  compel  future  invest- 
ments in  them.  Each  investor  \Nall  insist  on  ha\'ing  the  profit  to 
which  he  thinks  he  is  entitled,  regardless  of  public  opinion  on  the 
subject,  and  the  effect  of  providing  that  only  a  small  return  shall  be 
derived  form  the  railway  or  any  other  business,  will  simply  be  to 
drive  the  investment  from  that  business  to  other  businesses  whose 
profits  are  not  limited." 

10.  In  this  paper  the  conditions  and  circumstances  will  be  con- 
sidered which  should  influence,  or  control,  the  fixing  of  the  fair 
rate  of  profit.  A  utility  company  is  particularly  interested  in  the 
total  returns  from  its  entire  schedule  of  rates.  It  is  also  interested 
in  the  distribution  of  profit  over  particular  rates,  for  this  will  have 
much  to  do  with  the  growth  of  its  business.  A  customer  is  par- 
ticularly interested  only  in  his  own  rate. 

11.  If  the  rate  of  profit  is  too  low,  money  cannot  be  readily 
obtained  for  the  development  of  the  business.  If  it  is  too  high, 
competition  is  invited.  It  is  coming  to  be  generally  conceded  that 
a  utility,  which  must  occupy  the  streets  with  poles,  wires,  conduits, 
pipes  or  tracks,  is  a  natural  monopoly,  and  that  regulation,  and  not 
competition,  is  the  best  remedy  to  be  applied  in  its  control.  Compe- 
tition chiefly  acts  to  reduce  that  part  of  the  rate  which  consists  of 


132  DEVELOPMENT  OF  SCIENTIFIC  RATES 

profit.     It  does  not  have  much  effect  upon  the  costs  which  constitute 
the  remainder. 

12.  The  question  of  reasonable  profit  does  not  ordinarily  pre- 
sent itself,  until  after  a  utility  has  been  built,  and  has  been  in 
operation  for  a  sufficient  length  of  time  to  show  results.  At  the 
outset,  the  utility  must  adopt  a  tentative  rate  or  schedule  of  rates, 
the  results  of  which  can  only  be  conjectured.  No  court  or  commis- 
sion has  ever  been  called  upon  to  pass  upon  the  reasonableness  of 
a  rate  in  advance  of  the  building  of  the  plant.  In  all  cases  where 
the  question  of  the  reasonableness  of  rates  has  been  so  passed  upon, 
the  rates  have  been  in  efl^ect  for  some  time.  It  has  in  all  cases  been 
possible  to  value  property  already  in  existence,  and  to  test  the  pro- 
posed rate  by  calculating  the  return  it  would  have  realized,  if 
applied  to  past  business. 

13.  No  court  has  yet  decided  what  is  a  reasonable  rate  of 
profit.  The  courts  in  most  cases  have  merely  reviewed  the  deci- 
sions of  legislative  or  administrative  bodies,  which  have,  in  the 
exercise  of  their  powers,  fixed  certain  rates.  The  usual  occasion  for 
review  has  been  an  attack  on  the  validity  of  the  rate  on  the  consti- 
tutional ground  of  confiscation.  Even  in  the  few  cases  where  the 
decisions  of  the  commissions  have  been  reviewed  under  statutory 
provisions,  the  courts  have  emphasized  the  strong  presumption 
which  exists  in  favor  of  the  rate  as  fixed  by  the  administrative  body. 
In  some  States,  this  presumption  is  declared  by  statute. 

14.  The  courts  in  their  decision  have,  as  stated,  generally  con- 
fined their  inquiries  to  the  question  whether  the  rate  as  fixed  was 
so  confiscatory  as  to  violate  constitutional  principles.  They  have 
not  undertaken  to  themselves  exercise  the  rate-making  power,  nor 
to  consider  general  questions  of  expediency,  public  policy,  or  the 
best  interests  of  both  company  and  customer.  All  these  have  been 
recognized  as  matters  which  must  be  considered  by  a  rate-making 
body.  They  have  not,  however,  been  considered  by  the  courts, 
except  as  bearing  directly  on  the  question,  whether  the  rate  fixed 
was  so  unreasonable  and  unfair,  as  to  deprive  the  company  of  its 
property  without  due  process  of  law. 

15.  The  courts  have  thus  far  approached  the  question  as  they 
have  that  of  tax  assessments.  It  is  a  general  rule  that  if  an  assess- 
ment has  been  made  in  good  faith  by  the  assessing  officer,  and  is  not 
manifestly  unfair,  it  will  not  be  disturbed  by  the  courts.  There  is 
such  a  range  for  the  operation  of  individual  judgment  on  the  ques- 


REASONABLE  PROFIT  133 

tion  of  assessable  value,  that  it  cannot  ordinarily  be  said  that  a 
particular  value  is  too  high  or  too  low.  Tested  by  legal  principles, 
any  value  within  a  given  range  is  proper. 

16.  The  same  is  true  of  rates  for  a  public  service.  The  fixing 
of  the  proper  rate  of  return  is  a  matter  of  sound  judgment,  and  the 
courts  have  recognized  the  principle,  that  where  sound  judgment  has 
apparently  been  exercised,  and  the  results  are  not  manifestly  unfair, 
they  should  not  be  interfered  with.  Where,  however,  the  results  are 
clearly  unfair,  or  where  it  is  evident  that  the  rate-making  body  has 
not  investigated  the  question  in  good  faith,  the  courts  have  not  hesi- 
tated to  interfere,  and  it  is  in  this  class  of  cases  that  they  have  been 
called  upon  to  state  the  law. 

17.  This  view  is  well  put  by  the  court  in  the  case  of  Minne- 
apolis, St.  Paul  and  Sault  Ste.  Marie  Railroad  Company  vs.  Wiscon- 
sin Railroad  Commission,  136  Wis.  146, — where  this  language  is 
used: 

"In  reviewing  the  order  of  the  Railroad  Commission  the  inquiry  is  not 
whether  the  rate,  regulation,  or  service  fixed  by  the  Commission  is  just  and 
reasonable,  but  whether  the  order  of  the  Commission  is  unreasonable  or 
unlawful.  The  nature  of  the  inquiry  is  changed  at  this  point,  and  the  court 
is  not  investigating  for  the  purpose  of  establishing  a  fixed  point.  Whether 
or  not  the  order  is  within  the  field  cf  reasonableness,  or  outside  of  its  bound- 
aries, is  the  question  for  the  court.  It  is  quite  a  different  question  from 
that  which  was  before  the  Commission  in  this  respect.  The  order  being 
found  by  the  court  to  be  such  that  reasonable  men  might  well  differ  with 
respect  to  its  correctness,  it  cannot  be  said  to  be  unreasonable.  From 
this  aspect  it  is  within  the  domain  of  reason,  not  outside  of  its  boundaries. 
This  is  the  viewpoint  of  the  reviewing  court." 

18.  In  this  paper  we  are  not  concerned  particularly  with  legal 
questions,  although  a  number  of  court  decisions  will  be  found  cited 
in  the  appendix.  We  shall  try  to  place  ourselves  at  the  viewpoint, 
not  of  a  court  to  which  appeal  may  have  been  made  from  a  rate 
already  fixed,  but  of  the  rate-making  body.  What  elements  should 
such  a  body  consider  in  arriving  at  a  sound  conclusion  upon  the 
question  of  the  reasonable  rate  of  profit?  There  must  be  some 
principles  to  guide  in  the  determination  of  what  rate  a  public  utility 
should  earn,  and  the  pubHc  should  pay. 

19.  As  already  stated,  the  rate  of  return  must  be  such  as  will 
readily  bring  the  needed  money  into  the  business.  It  should  not  be 
the  policy  of  the  rate-making  body  to  first  permit  the  investment  of 
capital  in  public  utilities,  and  when  the  investment  has  been  made, 


134  DEVELOPMENT  OF  SCIENTIFIC  RATES 

to  so  limit  the  rate  of  return  upon  it,  that  those  who  have  made  the 
investment  have  reason  to  regret  doing  so.  Capital  already  invested 
should  receive  exactly  the  same  consideration  and  treatment  as 
capital  about  to  be  invested.  The  former  should  be  fairly  treated, 
and  the  latter  should  not  be  invited  with  the  prospect  of  a  profit 
not  inherently  reasonable.  While  the  foregoing  principle  should  be 
axiomatic,  difficulties  arise  in  its  application  to  specific  cases. 

20.  From  the  decision  of  the  United  States  Supreme  Court  in 
the  Consolidated  Gas  Company  case  (see  appendix),  some  have 
gained  the  impression  that  it  has  been  decided  that  six  per  cent  is  a 
fair  rate  of  return.  This  case  is,  however,  merely  one  of  the  class 
already  (14)  referred  to.  It  merely  decided  that  six  per  cent  was 
not  unreasonably  low.  The  New  York  Legislature  has  passed  two 
acts,  one  limiting  the  price  of  gas  sold  to  the  city  of  New  York  to  a 
sum  not  to  exceed  75  cents  per  M.  cubic  feet,  and  another  limiting 
the  price  in  the  boroughs  of  Manhattan  and  the  Bronx,  to  consumers 
other  than  the  city  of  New  York,  to  80  cents  per  M.  cubic  feet. 
The  New  York  Gas  Commission  (succeeded  by  the  Public  Service 
Commissions  in  1907)  had  also  made  an  order  providing  that  the 
price  of  gas  in  the  city  of  New  York  should  not  be  more  than  80 
cents  to  consumers  other  than  the  city  of  New  York. 

21.  Both  the  legislature  and  the  commission  had  exercised 
their  judgment  in  the  matter,  and  their  decision  was  not  to  be  over- 
ruled, unless  it  resulted  in  manifest  injustice.  The  court  in  its 
opinion  stated:  "The  rule  by  which  to  determine  the  question  (as 
to  the  validity  of  the  acts  of  the  legislature  and  commission)  is 
pre'tty  well  established  in  this  court.  The  rates  must  be  plainly 
unreasonable  to  the  extent  that  their  enforcement  would  be  equiva- 
lent to  the  taking  of  property  for  public  use,  without  such  compen- 
sation as,  under  the  circumstances,  is  just  both  to  the  owner  and  the 
public.  There  must  be  a  fair  return  upon  the  reasonable  value  of 
the  property  at  the  time  it  is  being  used  for  the  public."  The  court 
concurred  in  the  opinion  of  the  trial  judge  that  "a  rate  which  would 
permit  a  return  of  six  per  cent  would  be  enough  to  avoid  the  charge 
of  confiscation."  In  concluding,  the  court  said,  "Upon  a  careful 
consideration  of  the  case  before  us,  we  are  of  the  opinion  that  the 
complainant  (the  Gas  Company)  has  failed  to  sustain  the  burden 
cast  upon  it,  of  showing  beyond  any  just  or  fair  doubt  that  the 
acts  of  the  legislature  of  the  State  of  New  York  are  in  fact  confis- 
catory."    The  bill  of  complaint  was  dismissed,  without  prejudice  to 


REASONABLE  PROFIT  135 

the  company's  right  to  again  have  recourse  to  the  court,  if  actual 
experience  under  the  rates  prescribed  prevented  it  from  earning  a 
fair  return. 

22.  The  trial  court  had  found  that  the  company  was  operating 
"the  most  favorably  situated  gas  business  in  America."  In  dis- 
cussing the  question  of  reasonable  profit,  Justice  Peckham  said, 
"There  is  no  particular  rate  of  compensation  which  must  in  all 
cases,  and  in  all  parts  of  the  country,  be  regarded  as  sufficient  for 
capital  invested  in  business  enterprises.  Such  compensation  must 
depend  greatly  upon  circumstances  and  locality.  Among  other 
things,  the  amount  of  risk  in  the  business  is  a  most  important  factor, 
as  well  as  the  locality  where  the  business  is  conducted;  and  the  rate- 
expected  and  usually  realized  upon  investments  of  a  somewhat  simi- 
lar nature  with  regard  to  the  risk  attending  them." 

23.  In  the  Knoxville  Water  Company  case  (see  appendix),  the 
United  States  Supreme  Court  held  that  interference  by  the  Court 
was  not  warranted,  it  appearing  that  the  value  of  the  Company's 
property  was  open  to  such  question,  that  the  effect  of  the  rate  fixed 
by  the  city  ordinance  was  speculative.  The  Company's  bill  of  com- 
plaint was  dismissed  without  prejudice,  with  the  right  to  again  apply 
to  the  court  for  relief,  if  thereafter  it  should  appear,  under  the  actual 
operation  of  the  ordinance,  that  the  returns  allowed  by  it  operated 
as  a  confiscation  of  property.  It  was  clear,  upon  any  view  of  the 
evidence,  that  the  company  would  receive  some  compensation  under 
the  ordinance  rate;  the  question  of  how  much  was  entirely  specula- 
tive. As  stated  by  Justice  Moody,  "The  net  income  in  any  event 
would  be  substantially  six  per  cent,  or  four  per  cent  after  an  allow- 
ance of  two  per  cent  for  depreciation,  etc.  We  cannot  know  clearly 
that  the  revenue  would  not  much  exceed  that  figure." 

24.  The  Railroad  Commission  of  Wisconsin  has  in  several  cases 
exercised  the  authority  given  to  it  to  fix  just  and  reasonable  rates  and 
schedules  for  electric,  gas  and  water  utilities.  In  the  case  of  Menom- 
inee and  Marinette  Light  and  Traction  Company  (decided  August  3, 
1909,  see  appendix),  the  Commission  used  a  rate  of  7%  on  the  cost 
of  reproduction  new  as  the  basis  for  the  schedule  of  rates  ordered  to 
be  put  into  effect.  In  the  case  of  Antigo  Water  Company  (decided 
August  3,  1909,  see  appendix),  the  Company's  net  earnings  did  not 
much  exceed  six  per  cent,  and  the  Commission  declined  therefore  to 
order  a  reduction  in  the  water  rates. 


136  DEVELOPMENT  OF  SCIENTIFIC  RATES 

25.  In  the  case  of  Madison  Gas  &  Electric  Company  (decided 
March  8,  1910,  see  appendix),  the  Commission  used  l}/2%  as  the 
reasonable  return  upon  the  value  of  the  gas  plant,  and  8%  as  the 
reasonable  return  upon  the  value  of  the  electric  plant.  The  Com- 
mission allowed  6%  in  each  case  for  interest,  with  an  additional 
1H%  and  2%  respectively /or  profit.  The  plants  were  considered  as 
favorably  situated,  their  credit  good  and  their  earnings  safe.  The 
utility  was  held  entitled  to  something  more  than  mere  interest  on  its 
investment.  The  gas  plant  had  in  the  past  earned  73^2%  on  the  value 
of  the  investment,  and  the  electric  plant  had  in  the  past  earned  8%, 
thus  indicating  in  the  opinion  of  the  Commission  that  the  cost  of 
reproduction  represented  the  maximum  value  for  rate-making  pur- 
poses, and  that  no  additional  value  should  be  credited  to  represent 
the  cost  of  building  up  the  business. 

26.  In  arriving  at  the  present  value  of  the  plants,  the  Commis- 
sion considered  the  cost  of  reproduction  new,  the  cost  of  reproduction 
new  less  depreciation,  their  original  cost,  book  value,  and  capitaliza- 
tion, their  gross  earnings,  operating  expenses  and  net  earnings,  and 
the  cost  of  building  up  the  business  as  shown  by  the  value  of  the  gas 
plant  when  computed  on  a  1(}/2%  earning  basis,  by  the  value  of  the 
electric  plant  when  computed  on  an  8%  earning  basis,  and  by  the 
value  of  both  plants  combined  when  figured  on  an  8%  earning  basis. 
The  risks  of  the  electric  business  were  considered  greater  than  those 
of  the  gas  business,  and  a  larger  return  for  interest  and  profit  was 
therefore  allowed  upon  the  present  value  of  the  electric  plant. 

27.  In  the  Coney  Island  Fare  cases  (decided  March  8,  1910), 
the  New  York  Public  Service  Commission,  First  District,  held  that 
returns  of  8.46%,  7.62%,  7.56%  and  6.57%,  respectively,  upon  a  low 
valuation  of  the  properties  involved,  were  not  unreasonable.  No 
allowance  had  been  made,  in  valuing  the  properties,  for  develop- 
ment expenses  and  other  elements  which  should  properly  have  been 
considered.  The  Commission  held  that  it  was  not  necessary  in  the 
cases  before  it  to  go  further  into  the  matter  of  valuation,  and  dis- 
missed the  complaints.  The  New  York  Commissions  are  now  en- 
gaged in  hearing  some  cases  involving  electric  rates,  but  decisions 
have  not  yet  been  rendered. 

28.  The  situation  in  Great  Britain,  where  the  London  Shding 
Scale  is  much  in  use,  is  of  interest.  Mr.  W.  H.  Gardiner,  Jr.,  states 
in  his  recent  paper  on  that  subject,  "In  England  new  investments  in 
new  lighting  enterprises  are,  at  the  start,  allowed  to  earn  10%  on  the 


REASONABLE  PROFIT  137 

investment.  Only  after  an  undertaking  has  become  well  estab- 
lished and  free  from  initial  risks,  are  its  future  earnings  lowered,  by 
its  being  obliged  to  sell  its  subsequent  issues  of  securities  at  auction." 

29.  The  weight  of  authority  is  that  the  rate  of  profit  is  to  be 
earned  upon  the  present  fair  value  of  the  property  used  in  the  service 
of  the  public,  and  not  on  construction  cost.  If  a  plant  has  been 
built  with  reasonable  foresight  and  good  judgment,  and  a  full  depre- 
ciation account  has  been  established,  the  present  value  of  plant, 
plus  the  amount  in  the  depreciation  reserve,  should  equal  the  amount 
of  the  original  investment,  and  the  original  capital  has  been  main- 
tained without  impairment.  If  this  is  not  so,  it  indicates  that 
depreciation  has  not  been  properly  taken  care  of,  and  the  rule  for- 
bids that  profit  should  be  earned  on  value  which  has  ceased  to  exist. 

30.  If  proper  depreciation  has  been  charged  off,  but  the  plant 
has  been  unable  to  earn  a  fair  profit,  such  deficiency  of  profit  prop- 
erly becomes  a  part  of  the  "going- value,"  or  cost  of  building  up  the 
business,  and  the  company  is  entitled  to  capitalize  it,  and  earn  a 
profit  thereon,  in  later  years,  assuming  that  the  value  of  the  service 
will  then  warrant  this  additional  charge,  and  that  the  earlier  deficits 
arose  notwithstanding  good  management  and  reasonable  foresight. 

31.  It  may  be,  however,  that  the  decrease  in  the  value  of  the 
investment  is  greater  than  any  possible  depreciation  reserve.  Con- 
ditions may  have  so  changed,  that  the  operation  of  the  plant  will 
not  provide  for  depreciation  and  a  fair  profit.  The  capital  has,  in 
such  a  case,  been  impaired  in  spite  of  good  management  and  reason- 
able foresight.  Such  a  possibility. is  one  of  the  risks  of  the  business, 
and  to  be  considered  as  warranting  a  higher  rate  of  return. 

32.  Present  value  is  generally  reached  by  taking  the  reproduc- 
tion cost,  and  deducting  therefrom  the  depreciation.  If  an  ade- 
quate depreciation  reserve  has  been  reinvested  in  the  plant,  this 
present  value  equals  the  original  cost  or  investment,  the  deprecia- 
tion charged  against  the  same  being  balanced  by  reserve  reinvested. 
As  a  rule,  however,  depreciation  has  been  neglected  to  a  greater  or 
less  extent. 

33.  The  courts  have  not  held  definitely  that  the  rate  of  return 
is  to  be  computed  on  the  basis  of  actual  present  value.  They  have 
held  that  the  basis  of  the  calculation  is  "a  fair  value  of  the  property 
being  used  for  the  convenience  of  the  public,"  and  that,  in  order  to 
ascertain  this  fair  value,  both  the  original  cost  of  construction,  and 
the  present  value,  are  to  be  considered. 


138  DEVELOPMENT  OF  SCIENTIFIC  RATES 

34.  Let  it  be  assumed  that  an  investment  has  been  made  by  the 
stockholders  of  a  utility  company,  upon  which  they  are  able  to  earn 
eight  per  cent.  If  the  value  of  a  certain  portion  of  the  property 
appreciates  faster  than  the  value  of  other  portions  depreciates,  no 
net  depreciation  has  occurred.  If  the  value  appreciates,  it  is  clear 
that  a  competitor  entering  the  field,  will  have  to  make  an  invest- 
ment equal  to  the  increased  value  of  the  plant  already  in  operation. 
The  increase  in  the  value  of  the  investment  may  be  due  to  foresight 
in  the  selection  of  good  localities  for  plant  and  distributing  system, 
and  to  the  growth  of  the  community.  Ordinarily  a  company  cannot 
very  well  raise  its  rates,  but  if,  by  the  increase  of  business  at  old 
rates  or  newer  and  lower  rates,  it  earns  a  considerably  greater  per- 
centage than  8%  upon  its  investment,  why  is  not  its  service  worth 
it?     iVnd  why  should  it  not  then  reap  the  harvest  of  its  foresight.'^ 

35.  On  the  other  hand,  let  it  be  assumed  that  an  investment 
has  been  made  of  an  equal  amount,  with  apparently  equal  foresight 
and  judgment,  in  another  community.  By  reason  of  the  retrogres- 
sion in  growth  of  the  community,  or  by  reason  of  the  arrival  of 
cheaper  methods  of  supply,  the  value  of  the  investment  shrinks  at 
such  a  rate  that  there  is  no  prospect  of  the  company  ever  making 
good  the  impairment.  The  selling  value  of  the  service  has  de- 
creased, while  the  Company's  costs  have  not.  The  Company 
cannot  increase  its  charges,  and  thereby  increase  its  rate  of  return, 
as  applied  to  the  diminished  value  of  its  original  investment.  A 
competitor,  coming  into  the  field,  can  successfully  compete,  with 
an  investment  equal  to  the  depreciated  value  of  the  investment  of 
the  older  company. 

36.  The  possibility  of  such  a  condition  is  one  of  the  risks  of  the 
business  assumed  by  the  investors.  It  is  one  which  may  be  par- 
tially insured  against  by  a  larger  rate  of  profit  in  the  earlier  years. 
It  should  be  so  insured  against,  wherever  the  value  of  the  service 
is  such  as  to  carry  the  additional  charge  necessary  to  provide  for 
it.  If  the  State  does  not  guarantee  against  loss  where  the  enter- 
prise is  a  failure,  it  should  not  unduly  restrict  the  rate  of  profit 
where  it  is  a  success.  The  State  should  not  seek  to  appropriate 
the  unearned  increment  in  one  case,  and  in  the  other  case  let 
the  undeserved  decrement  fall  on  the  owners. 

37.  In  the  Consolidated  Gas  Company  case,  the  United  States 
Supreme  Court  said: 


REASONABLE  PROFIT  139 

"We  concur  with  the  court  below  in  holding  that  the  value  of  the 
property  is  to  be  determined  as  of  the  time  when  the  inquiry  is  made 
regarding  the  rates.  If  the  property,  which  legally  enters  into  the  con- 
sideration of  the  question  of  rates,  has  increased  in  value  since  it  was 
acquired,  the  company  is  entitled  to  the  benefit  of  such  increase.  That  is, 
at  any  rate,  the  general  rule.  We  do  not  say  that  there  may  not  possibly 
be  an  exception  to  it,  where  the  property  may  have  increased  so  enormously 
in  value  as  to  render  a  rate  permitting  a  reasonable  return  upon  such  in- 
creased value  unjust  to  the  public.  How  such  facts  should  be  treated 
is  not  a  question  now  before  us,  as  this  case  does  not  present  it.  We  refer 
to  the  matter  only  for  the  purpose  of  stating  that  the  decision  herein  does 
not  prevent  an  inquiry  into  the  question  when,  if  ever,  it  should  be  neces- 
sarily presented." 

38.  Another  of  the  contingencies  to  be  considered  is  the  matter 
of  the  term  of  the  franchise,  under  which  the  utility  is  operating. 
If  this  franchise  is  one  similar  to  that  known  in  Wisconsin  as  "inde- 
terminate," and  which  is  to  continue  until  the  municipality  shall 
see  fit  to  acquire  the  utility  at  a  proper  valuation,  the  franchise  is 
an  unimportant  element.  If  the  franchise  fixes  rates,  then,  like 
every  other  contract,  it  may  have  value,  but  the  Company  operating 
under  such  a  franchise  is  not  subject  to  rate  regulation,  and  its  rate 
of  profit  is  beyond  our  present  inquiry.  If  a  utility  accepts  a  short 
term  franchise,  it  must  be  held  to  have  done  so  with  full  knowledge 
of  the  risks  involved.  Such  risks,  however,  should  be  compensated 
for,  and  the  public,  in  restricting  the  term  of  the  privileges  it  has 
granted,  and  the  utility  in  accepting  the  restriction,  must  each  be 
considered  to  have  been  willing  to  accept  the  burdens  with  the 
benefits.  If  a  short  term  franchise  is  of  advantage  to  the  public, 
the  public  must  be  willing  to  allow  a  higher  rate  of  return  to  cover 
the  risk  of  unfavorable  terms  of  renewal,  or  denial  of  renewal. 

39.  Certain  expenditures  of  every  public  utility  are  unpro- 
ductive. These  expenditures  include  those  made  in  the  interests  of 
public  safety  and  convenience;  for  instance  in  our  business,  the 
underground  construction  which  we  have  had  to  substitute  for 
equally  effective  overhead  lines.  These  must  be  paid  for  either  out 
of  capital  or  earnings.  If  paid  for  out  of  capital,  the  productive 
capital  must  earn  an  amount  of  profit  sufficient  to  produce  a  reason- 
able return  upon  the  aggregate  investment,  both  productive  and  un- 
productive. If  paid  for  out  of  earnings,  these  must  be  sufficient  to 
provide  a  reasonable  return  upon  the  productive  capital,  and  also 
to  provide  for  the  unproductive  investment  itself,  either  in  a  shorter 
or  longer  period  of  time.  Of  course,  if  paid  for  out  of  earnings, 
these  improvements  should  not  be  capitalized,  and  a  proper  stock 


140  DEVELOPMENT  OF  SCIENTIFIC  RATES 

and  bond  law  will  prevent  such  practice.  In  the  pending  investiga- 
tion by  the  Interstate  Commerce  Commission  into  the  necessity  for 
increases  in  freight  rates,  the  view  has  been  expressed  by  Mr. 
James  McCrea,  President  of  the  Pennsylvania  Railroad,  and  by 
Mr.  E.  P.  Ripley,  President  of  the  Santa  Fe  System  (see  appendix) 
that  unproductive  investment  should  be  paid  from  earnings,  and  not 
be  made  a  permanent  charge  in  the  form  of  capitalization.  If  the 
items  of  depreciation  and  obsolescence  are  fully  recognized  and 
treated  as  elements  of  cost,  it  would  seem  that  it  is  immaterial 
whether  this  class  of  investments  is  paid  from  earnings  or  from 
capital.  The  policy  of  the  Pennsylvania  Ralroad  has  been  to  ex- 
pend "a  dollar  for  dividends  and  a  dollar  for  betterments."  What- 
ever the  proper  proportion  may  be,  the  present  recognition  of 
depreciation  and  obsolescence  as  proper  cost  items  is  a  restatement 
of  this  rule  in  another  and  more  correct  form. 

II — Collection  of  Profit  from  Classes  of  Customers 

40.  The  reasonable  profit  which  a  utility  is  entitled  to  receive 
must  result  from  the  operation  of  its  entire  schedule  of  rates.  This 
profit  is  the  difference  between  the  gross  earnings  and  expenses, 
including  in  the  latter,  of  course,  depreciation.  This  profit  will 
equal  some  rate  or  percentage  upon  the  investment,  which  rate  may 
be  reasonable  or  unreasonable. 

41.  If  the  profit  earned  by  the  company  is  reasonable,  it  fol- 
lows that  its  entire  schedule  of  rates,  on  the  average,  is  also  reason- 
able. But  this  does  not  prove  that  any  particular  rate  charged  by  it 
is  reasonable.  A  company  may  be  earning  but  a  reasonable  profit, 
and  yet  its  rates  may  be  open  to  the  charge  of  unjust  discrimination. 
Reasonable  profit  and  reasonable  specific  rates  have  no  necessary 
connection  with,  nor  absolute  relation  to,  each  other. 

42.  The  collection  of  the  reasonable  profit  from  the  various 
classes  of  the  company's  customers,  calls  for  the  exercise  of  careful 
judgment.  It  is  clear  that  the  profit  need  not  be  equally  distributed 
over  each  class  of  service.  It  may  be  proper,  or  even  necessary, 
for  one  class  of  service  to  bear  a  greater  portion  of  the  element  of 
profit  than  another.  The  law  permits  classification,  and  allows  a 
difference  in  rates,  where  there  is  a  difference  in  the  cost  of  service, 
and  the  rates  are  adjusted  thereto.  Economic  reasons  warrant  a 
different  rate  of  return  on  different  classes  of  business,  provided  the 
total  resultant  profit  is  reasonable. 


REASONABLE  PROFIT  141 

43.  There  is  no  legal  requirement  that  the  element  of  profit  in 
a  rate  to  a  class  must  be  proportionate  to  the  cost  of  serving  that 
class,  or  must  be  a  set  percentage  on  the  value  of  the  property  used 
in  performing  the  service.  Rates  cannot  be  made  by  exact  for- 
mula, and  an  attempt  to  distribute  profit  in  exact  proportion  to  the 
cost  of  serving  each  class,  would  be  a  practical  impossibility.  More- 
over, the  cost  of  the  service  to  each  class  is  not  the  only  test  of  the 
propriety  of  different  rates.  The  value  of  the  ser\^ce  to  each  class 
is  also,  under  the  decisions,  one  of  the  tests  of  reasonableness,  and 
its  difference  in  value  may  or  may  not  be  proportionate  to  the 
difference  in  cost.  Class  rates  are  offered  from  necessity;  they  must 
be  given  to  secure  the  business;  an  average  rate  will  secure  the 
business  of  the  class  to  whom  the  value  of  the  seiH'ice  is  above  this 
average,  but  will  not  that  of  the  class  to  whom  it  is  below  the 
average.  As  soon  as  we  reach  the  question  of  specific  rates,  aver- 
age profits  must  be  departed  from.  One  class  of  business  may 
legitimately  bear  more  profit  than  another. 

44.  If  two  parallel  railroads  with  the  same  termini,  having 
different  capital  invested  but  equal  operating  costs,  each  hauls  the 
same  number  of  tons  of  through  traffic,  the  aggregate  amount  of 
profit  on  this  through  traffic  will  be  about  the  same.  Competition 
between  the  roads  will  compel  this  condition.  If  the  roads  are  each 
to  earn  the  same  reasonable  profit  on  capital,  it  is  clear  that  the  road 
which  represents  the  greater  investment  must  earn  more  propor- 
tionately on  its  local  traffic,  than  the  road  which  represents  the  lesser 
investment.  It 'is  also  clear  that  the  local  traffic  on  the  former  road 
must  pay  a  greater  portion  of  the  total  annual  profit  than  the 
through  traffic. 

45.  The  same  condition  exists  in  the  furnishing  of  electric 
service.  The  price  of  electric  light  or  power  to  the  large  consumer 
is  limited  by  competition,  actual  or  potential.  If  the  company  is  to 
serve  the  large  user,  it  must  do  so  at  a  rate  lower  than  is  willingly 
paid  by  the  small  consumer.  It  costs  the  company  less  to  serve  a 
wholesale  consumer,  and  a  lower  class-rate  is  therefore  justified. 
It  is,  however,  not  merely  justified;  it  is  given  as  a  matter  of  neces- 
sity, for  otherwise  the  company  would  not  be  able  to  secure  the 
large  customers.  These  cannot  afford  to  pay  average  profit,  for  the 
service  to  them  is  not  worth  it.  It  must  be  offered  to  them  at  a 
price  nearer  to  their  individual  costs.  This  price,  of  course,  cannot 
be  varied  to  exactly  meet  individual  costs,  for  no  two  individual 


142  DEVELOPMENT  OF  SCIENTIFIC  RATES 

costs  are  the  same.  It  must  be  a  rate  offered  to  a  class,  and  not  to 
an  individual.  If  figured  to  meet  individual  costs,  it  would  cease 
to  be  a  rate,  and  could  not  be  distinguished  from  unjust  discrimi- 
nation. 

46.  A  class  rate  must  cover  class  cost.  The  cost  of  serving  a 
class  of  customers  must  be  determined,  and  a  company  making  a 
class  rate  should  be  prepared  to  prove  that  the  rate  is  more  than 
sufficient  to  cover  cost.  There  is  no  rule  or  decision,  however,  which 
requires  that  the  profit  to  be  earned  by  each  class  of  service,  shall 
be  proportionate  to  the  investment  made  to  serve  that  class.  It  is 
clearly  recognized  that  some  business  will  of  necessity  be  transacted 
at  a  less  profit  than  other  business.  In  other  words,  one  class  of 
business  must  caVry  a  greater  profit  than  another  class,  and  a  differ- 
ent rate  of  profit  on  well  defined  different  classes  of  service  does 
not  amount  to  discrimination. 

47.  In  papers  previously  presented  to  this  Association,  the 
writer  has  discussed  the  Status  of  Wholesale  and  Retail  Customers, 
and  the  Status  of  Ordinary  and  Special  Customers.  These  papers 
dealt  with  the  features  of  competitive  and  non-competitive  business, 
the  various  classes  of  service  which  an  electric  light  company  is 
called  upon  to  perform,  and  the  varied  cost  of  service  to  these  classes. 
It  is  not  desirable  or  necessary  to  repeat  here  the  discussion.  This 
paper  is  dealing  with  the  question  of  the  distribution  of  profit  over 
different  classes  of  service.  The  foregoing  paragraphs  show  that 
there  is  no  exact  rule  whereby  the  incidence  of  profit  may  be  deter- 
mined. The  following  is  a  statement  of  the  practical  limits  within 
which  a  company  in  making  rates  may  lawfully  apply  its  business 
judgment. 

(a)  No  class  of  business  should  be  done  at  a  loss.  As  a  proof 
that  there  is  not  a  loss,  rates  should  be  so  adjusted  that  each  class 
of  service  will  positively  show  a  profit,  although  that  profit  may  be 
small. 

(b)  No  class  of  business  should  be  required  to  carry  an  ex- 
orbitant profit.  The  conditions  surrounding  our  business  may 
usually  be  relied  upon  to  keep  customers  from  paying  a  rate  which 
contains  an  exorbitant  profit.  In  other  words,  when  a  class  of  cus- 
tomers readily  pays  a  certain  price  for  service,  it  may  be  assumed 
that  the  profit  earned  by  the  company  in  the  performance  of  that 
service  is  not  exorbitant. 


REASONABLE  PROFIT  143 

(c)  Between  limits  of  no  profit  and  exorbitant  profit,  the  value 
of  the  service  to  the  customer  must  guide  the  company  in  deter- 
mining the  profit  to  be  earned  by  each  class  of  service. 

The  propriety  of  an  entire  schedule  of  rates,  or  a  particular 
schedule  of  rates,  may  be  tested  by  determining  whether  it  will 
yield  a  fair  return;  but  this  test  will  not  serve  to  fix  for  a  particular 
rate  its  exact  position  between  the  stated  limits.  This  exact  fixing 
of  a  particular  rate  is  a  matter  of  judgment,  and  equally  so  whether 
the  judgment  be  exercised  by  the  utility,  or  by  a  commission  or 
other  public  authority. 

48.  A  public  utility  cannot  be  required  to  serve  the  entire 
body  of  its  customers  at  a  loss  to  itself,  and  a  rate  of  charge  pre- 
scribed by  the  Legislative  or  an  administrative  body,  the  operation 
of  which  will  deprive  the  utility  of  a  fair  return,  is  unlawful.  How- 
ever, a  rate  of  charge  may  have  been  fixed  which,  applied  to  the 
entire  business  of  a  company,  will  yield  a  fair  rate  of  return,  but 
which  applied  to  specific  customers  or  classes  of  customers,  deprives 
the  company  of  any  profit  on  such  customer  or  class.  The  Courts 
have  not  decided  that  a  class  rate,  which  does  not  itself  allow  a 
reasonable  profit,  is  lawful,  if  the  company  is  earning  a  reasonable 
profit  upon  its  entire  business.  The  United  States  Supreme  Court 
has  expressly  left  the  question  open  for  future  determination.  In 
none  of  the  cases,  where  the  question  was  discussed,  were  the 
proofs  clear  that  the  company  was  not  earning  a  profit  under  the 
rate  complained  of.  A  company  must  have  different  rates  for  dif- 
ferent classes  of  service,  and  it  is  entitled  to  earn  a  reasonable 
profit,  although  not  necessarily  the  same  rate  of  profit,  on  each  class. 
A  rate  of  charge  which  deprives  it  of  a  reasonable  profit  on  a  par- 
ticular class  of  business  is  confiscatory. 

49.  The  courts  have  held  that  a  railroad  is  an  entirety,  and 
that  a  rate  of  charge  for  carrying  passengers  may  not  be  unfair, 
although  it  is  not  remunerative  when  applied  to  but  one  portion  of 
its  road.  In  the  case  of  a  railroad,  however,  traffic  will  move  even 
at  an  excessive  rate,  unless  it  is  more  than  the  traffic  will  bear. 
Passenger  traffic  will  move  at  rates  in  themselves  excessive.  People 
must  travel,  and  will  pay  high  rates,  although  grudgingly,  rather 
than  not  travel  at  all.  It  is  practicable  for  a  railroad  to  make  up 
for  the  losses  incurred  in  the  operation  of  one  portion  of  its  road 
by  profits  made  in  the  operation  of  another.  A  rate  which  is  too 
low  on  one  part  of  the  system  may  be  supplemented  by  a  high  rate 


144  DEVELOPMENT  OF  SCIENTIFIC  RATES 

on  another  part,  and  the  resulting  combination  produce  a  fair  return. 
This  may  be  proper  in  the  particular  case  as  a  matter  of  public 
policy.  It  may  be  proper  for  those  favorably  situated  to  share  the 
burden  of  those  less  favorably  located. 

50.  The  same  principle  may  apply  to  a  certain  extent  in  freight 
rates  and  even  in  electric  rates.  Where,  however,  the  class  of  busi- 
ness which  it  is  proposed  shall  bear  the  greater  burden,  cannot  be 
made  to  pay  more  than  its  own  proper  share  considered  by  itself, 
the  principle  cannot  apply.  In  the  matter  of  electric  rates,  the 
large  consumer  is  in  position  to  serve  himself,  and  will  do  so,  if  the 
rate  charged  him  exceeds  the  cost  of  his  so  doing,  and  he  cannot 
be  made  to  bear  the  losses  incurred  by  the  company  in  furnishing 
service  at  less  than  cost  to  the  small  customer. 

51.  We  hear  much  of  the  phrase,  "cost  of  service,"  and  it  is 
claimed  that  such  cost,  plus  a  reasonable  rate  of  return  to  the  com- 
pany, should  be  the  limit  of  charge.  If  this  test  is  applied  to  a 
general  schedule  of  rates  (the  aggregate  returns  from  which  will 
produce  an  amount  equal  to  the  total  costs,  plus  the  reasonable  re- 
turn), it  is  a  practical  test,  whether  or  not  it  is  the  most  equitable 
basis  of  rate-making.  But  if  an  attempt  is  to  be  made  to  apply  this 
test  to  each  individual  customer,  then,  as  stated,  we  may  have  as 
many  different  rates  as  there  are  customers,  for  no  two  of  them 
furnish  the  same  conditions. 

52.  Some  claim  that  this  should  be  the  basis  for  the  making 
of  freight  rates.  These  claim  that  the  cost  of  carrying  each  article 
between  given  points  should  be  computed,  and  such  cost  be  then 
used  as  the  basis  for  the  rate.  Such  a  basis  is  not  only  impractica- 
ble, but  would  result  in  many  cases  in  rates  so  high  as  to  prevent 
much  traffic  from  moving  at  all.  The  basis  of  railroad  rates  has 
always  been  the  value  of  the  service,  and  while  there  have,  of  course, 
been  errors  in  judgment  in  fixing  rates  on  this  basis,  it  is  inherently 
correct. 

53.  In  the  Boston  Edison  Company  rate  investigation  in  1907, 
the  company  claimed  that  the  proper  basis  for  electric  rates  was 
cost  of  service;  that  the  aim  should  be  to  charge  'each  customer 
substantially  the  cost  to  the  company  of  supplying  him,  including 
a  reasonable  return  on  the  investment  made  in  his  behalf.  This 
claim  was  over-ruled  by  the  Massachusetts  Board  of  Gas  and  Elec- 
tric Light  Commissioners,  which  held  that  the  cost  of  service  to 
each  customer  was   not  the  proper  basis    (see  appendix).      If   the 


REASONABLE  PROFIT  145 

cost  of  service  to  each  customer  (including  reasonable  profit)  is  not 
the  proper  basis  of  rate-making,  it  follows  that  the  cost  of  service  to 
each  class  of  customers  (including  this  same  reasonable  profit)  is 
not  necessarily  the  basis  for  class  rates. 

54.  No  better  argument  has  been  recently  made  against  the 
impropriety  of  using  a  fair  return  upon  a  fair  value  of  the  invest- 
ment as  the  sole  test  of  the  reasonableness  of  a  specific  rate  charged 
customers,  than  that  by  Senator  Joseph  W.  Bailey,  in  his  address 
before  the  New  York  State  Bar  Association  last  January  (1910)  on 
the  subject,  "The  Power  to  Regulate  Transportation  Charges  by 
Statutory  Enactment"  (a  portion  of  which  is  quoted  in  the  appen- 
dix). In  his  address  he  used  the  illustration  of  two  parallel  railroads 
serving  the  same  territory,  each  built  with  the  same  judgment  and 
economy,  but  at  an  unequal  cost.  He  convincingly  argues  that  to 
apply  the  same  specific  rate  of  profit  to  each  investment,  would 
necessarily  result  in  the  driving  of  tonnage  to  the  cheaper  railroad. 
The  illustration  is  used  to  demonstrate  that  the  test  of  a  reasonable 
rate  is  not  a  specific  profit  upon  investment,  but  just  compensation 
under  all  the  circumstances. 

55.  The  same  illustration  may  be  used  in  arriving  at  a  proper 
solution  of  the  question  of  the  reasonable  profit  to  be  earned  by  an 
electric  utility.  If  a  given  community  be  served  by  one  central 
station,  the  latter  should  be  satisfied  w4th  a  reasonable  profit,  and 
such  profit  will  serve  as  one  of  the  factors  which,  together  with 
operating  costs  and  depreciation,  will  make  up  the  schedule  of  rates. 
Where  there  is  but  one  utility  furnishing  a  given  service  in  a  com- 
munity, the  situation  is  comparatively  simple,  and  a  full  and  fair 
rate  of  profit  can  and  should  be  included  in  making  a  schedule  of 
rates. 

56.  But  there  may  be  in  a  given  community  two  electric  utili- 
ties, one  of  which  has  been  engaged  in  serving  the  public  through 
the  various  stages  of  the  growth  of  the  business,  and  with  a  plant 
not  entirely  up  to  date.  The  other  may  own  and  operate  a  plant 
modern  in  every  particular,  and  may  have  been  able  to  avail  itself 
of  the  latest  developments  in  the  art.  Both  may  be  of  equal  capacity 
and  may  be  serving  in  the  same  area.  The  investment  of  the  second 
plant  will  be  less  than  that  of  its  older  competitor.  If  each  is  to  earn 
a  specific  rate  of  profit  (say  8  or  10%)  on  its  investment,  the  newer 
plant  will  unavoidably  undersell  its  rival.  If  the  newer  plant  is 
willing  to  mantain  the  same  rate  as  the  older  one,  then  its  profits 


146  DEVELOPMENT  OF  SCIENTIFIC  RATES 

will  be  larger.  If  it  is  willing  to  reduce  its  profits,  it  may  undersell 
its  rival,  and  still  earn  a  greater  rate  of  profit.  This  situation  is 
not  a  theoretical  one;  it  exists  in  many  places. 

57.  The  newer  plant  may,  as  stated,  be  a  vigorous  rival  located 
in  the  same  area,  or  it  may  be  a  water  power  in  the  vicinity,  which 
desires  to  dispose  of  its  energy  by  bringing  current  over  a  long  dis- 
tance transmission  line.  Which  investment  is  to  determine  the 
reasonable  profit  to  be  used  in  fixing  the  reasonable  rate  of  charge 
to  the  public?  If  the  newer  company  does  not  undertake  to  serve 
the  entire  community,  but  merely  seeks  to  serve  the  best  and  most 
available  customers,  such  as  the  long-hour  customer  and  the  large 
user,  and  makes  no  effort  to  serve  the  less  desirable  customers,  what 
is  to  become  of  the  older  company,  with  its  investment  in  plant  and 
distributing  system.^  If  it  meets  the  competition  where  necessary, 
it  must  raise  its  rates  to  the  smaller  customers,  if  it  is  to  earn  its 
specific  rate  of  profit.  This  situation  has  been  before  the  Massa- 
chusetts Commission  in  the  Fitchburg  and  Worcester  cases,  and 
was  there  solved  by  restricting  the  Connecticut  River  Transmission 
Company  to  the  sale  of  its  current  to  the  local  distributing  company, 
and  to  customers  whose  demand  was  300  kw.  or  more. 

58.  The  question  under  discussion,  however,  is  upon  what  shall 
the  reasonable  profit  be  based,  and  how  should  it  be  distributed. 
The  smaller  customer  deserves  equal  consideration  with  the  larger. 
Cheaper  investments,  cheaper  sources  of  production  and  lower 
operating  cost,  due  to  the  use  of  larger  units,  should  not  operate  to 
reduce  the  prices  to  the  larger  consumer,  and  raise  the  prices  to  the 
smaller  ones.  If  the  newer  company  is  to  be  required  to  serve 
throughout  the  entire  al*ea,  and  to  serve  both  the  large  and  the 
small  users,  then  the  result  is  duplication  of  distributing  investment, 
and  a  loss  of  the  economies,  which  will  result  if  the  newer  company 
is  allowed  to  restrict  its  operations.  On  the  other  hand,  however, 
if  it  is  allowed  to  so  restrict  its  operations,  it  will  result  in  reducing, 
and  perhaps  destroying,  the  reasonable  profit  of  the  older  company, 
unless  it  increases  its  rates  to  the  user  who  is  not  in  position  to  avail 
himself  of  the  competition  which  has  entered  the  field.  The  value 
of  the  service  to  the  smaller  user  has  not  been  increased  because  of 
the  cheap  supply  available  to  the  larger  user.  In  fact,  the  value  of 
the  service  to  neither  class  is  changed.  The  newer  service  is  the 
same  service,  supplied,  however,  by  a  different  utility  company. 

59.  If  a  given  rate  of  profit  is  to  be  used  to  determine  the  rate 


REASONABLE  PROFIT  147 

of  charge,  which  investment,  the  old  or  the  new,  the  cheaper  or  the 
more  expensive,  is  to  be  used  as  the  basis  to  which  the  rate  of  profit 
is  to  be  applied?  Does  it  not  appear  that  the  rate  of  profit  must 
vary,  and  that  the  older  company  must  be  satisfied  with  a  lower 
rate  of  return  than  its  competitor?  These  possibilities  should  be 
given  full  consideration  in  determining  the  rate  of  return  that 
should  be  allowed  to  an  existing  company.  In  other  words,  the 
risks  of  the  business  should  be  fully  considered  in  determining  the 
reasonable  profit  to  which  a  company  is  entitled;  including  among 
those  risks  the  possibility  that  advances  in  the  state  of  the  art, 
the  production  of  electric  energy  in  newer  ways  and  from  other 
sources,  may  at  any  time  become  factors  which  will  operate  to 
overthrow  the  calculations  of  the  most  prudent,  and  to  prove  that 
what  is  today  considered  a  reasonable  profit,  is  not  such  in  fact. 
This  has  been  proved  in  the  case  of  gas  and  water.  Natural  gas 
piped  from  a  distance  affected  the  earnings  of  many  gas  plants. 
New  sources  of  water  supply  have  made  former  sources  practically 
useless. 

60.  Fair  rates  do  not  necessarily  mean  a  low  rate  of  profit. 
Large  profits  may  result  from  just  rates.  As  stated  by  Commis- 
sioner Prouty  in  the  Spokane  case  (I.  C.  C.  June  17,  1910)  rates 
should  not  be  reduced  merely  because  the  utility  is  earning  large 
profits.  In  fixing  a  specific  rate,  a  Commission  must  consider 
whether  the  result  will  be  to  deprive  the  utility  of  a  fair  return  on 
its  property.  The  purpose  of  such  inquiry  in  the  Spokane  case  was 
declared  to  be  not  to  ascertain  whether  rates  should  be  reduced,  but 
whether  they  coiild  properly  be  reduced,  if  other  reasons  required 
such  reduction. 

61.  A  rate  of  return  merely  equal  to  the  rate  of  interest  on 
money  loaned  on  good  security  is  not  a  sufficient  return  to  those 
engaged  in  managing  a  business.  There  must  be  some  inducement 
offered  to  the  investment  of  capital  in  any  business,  including  the 
business  of  serving  the  public.  This  was  emphasized  by  the  Wis- 
consin Commission  in  the  Madison  case  (referred  to  above)  where 
an  additional  percentage  for  profit  was  allowed  over  and  above  six 
per  cent  allowed  as  interest. 

6^2.  It  occasionally  happens  that  a  new  company  is  organized 
to  take  over  a  going  concern,  which  has  become  inadequate  to  care 
for  the  needs  of  the  community  in  which  it  is  located,  or  it  may  be 
that  a  stronger  organization  in  or  near  the  community  acquires  such 


148  DEVELOPMENT  OF  SCIENTIFIC  RATES 

going  concern.  The  existing  utility  may  be  operating  a  plant  and 
system,  which  has  not  been  kept  up,  and  has  become  out  of  date. 
The  owners  may  not  have  kept  an  adequate  depreciation  account, 
or  may  have  allowed  their  capital  to  have  become  seriously  im- 
paired, by  taking  too  much  out  of  the  business  in  the  way  of  divi- 
dends or  otherwise.  Their  plant  has  a  going  value,  but  perhaps 
little  more.  The  newer  organization  may  be  in  position  to  suc- 
cessfully destroy  this  going  value  by  competition,  or  it  may  prefer 
to  purchase  the  plant  and  system  of  the  existing  organization,  as  the 
most  business-like  way  of  establishing  itself  in  the  community. 
Having  done  so,  the  newer  or  stronger  organization  finds  it  necessary 
to  entirely  discard  the  old  plant  and  system,  and  substitute  a  new 
and  up-to-date  one.  The  original  plant  is  thus  wiped  out,  and  its 
tangible  value  disappears.  The  intangible  value  is  at  once  attached 
to  the  newer  utility,  and  its  value  is  thereby  increased.  It  does  not, 
therefore,  have  to  go  through  the  ordinary  course  of  development  in 
the  community,  or  build  up  a  new  business.  The  courts  have  held 
that  good  will  as  such  does  not  exist  in  a  public  service  investment, 
owing  to  its  being  a  natural  monopoly.  Clearly,  however,  the  plant 
and  system  of  the  newer  organization  is  worth  more,  owing  to  the 
fact  that  it  is  at  once  conducting  an  established  business. 

63.  It  is  evident  that  the  value  of  the  old  plant  and  system, 
thus  purchased  and  discarded,  must  either  be  capitalized  or  charged 
off.  If  capitalized  at  the  price  paid  for  it,  it  must  earn  the  same 
reasonable  rate  of  profit  as  the  rest  of  the  capitalization  which 
represents  tangible  value.  If  charged  off,  either  at  once  or  over  a 
period  of  years,  it  will  result  in  higher  rates  of  charge  for  the  service 
rendered.  The  change  may  be — and  probably  is — one  that  is 
clearly  to  the  advantage  of  the  community,  and  in  such  case  those 
who  have  promoted  and  effected  the  change  should  receive  a  return 
for  their  energy  and  foresight  in  the  shape  of  profits  upon  capitaliza- 
tion, which  represents  intangible  value  as  well  as  that  which  is 
tangible.  Those  using  the  service  in  the  community  cannot  afford 
to  pay  higher  rates  of  charge  than  those  in  other  nearby  com- 
munities, served  by  the  same  utility,  and  it  will  in  most  cases  be 
inexpedient  or  practically  impossible  to  pay  for  the  value  of  the 
older  utilty,  which  has  thus  disappeared,  in  any  other  way  than  by 
thus  capitalizing  such  value.  Such  capital  cannot  fairly  be  said  to 
be  water,  and  yet  it  represents  something  intangible,  and  creates  a 
difference  between  the  capitalization  of  the  enterprise  and  the  re- 
production cost  of  the  physical  plant. 


REASONABLE  PROFIT  149 

64.  If  the  newer  organization  is  serving  several  communities, 
then  by  capitalizing  such  value,  which  has  disappeared  as  a  tangible 
asset,  the  entire  set  of  communities  served  by  the  utility  is  called 
upon  to  pay  rates  of  charge,  which  will  provide  a  fair  rate  of  profit 
upon  such  total  capitalization.  However,  the  larger  the  plant  and 
system  of  a  utility  (providing  it  is  not  trying  to  serve  too  extended 
an  area),  the  more  cheaply  can  the  service  be  rendered  to  all.  The 
same  reasons  which  operate  to  make  it  advisable  for  only  one  utility 
to  serve  a  given  community,  also  operate  to  make  it  advisable  that 
only  one  utility  serve  a  given  set  of  communities  within  a  compact 
area;  and  the  acquisition  of  an  out-of-date  plant  in  one  community, 
and  its  entire  reconstruction,  thus  operates  to  the  advantage  of  all 
the  nearby  communities  served  by  the  same  utility.  These  latter 
are  really  benefited  by  the  change,  even  although  a  portion  of  the 
capital,  upon  which  they  must  pay  a  reasonable  profit,  represents 
something  no  longer  tangible.  In  other  words,  the  fair  value  of  the 
property  used  in  serving  the  entire  area  or  set  of  communities,  and 
upon  which  profit  must  be  paid,  may  be  more  than  mere  reproduc- 
tion value.  Present  value  may  include  value  which  is  no  longer 
tangible.  The  history  of  the  development  of  a  utiHty  must  be  ex- 
amined in  arriving  at  its  present  value. 

65.  A  plant  and  system  must  be  built  with  reasonable  thought 
for  the  future.  If  a  plant  is  built  merely  for  the  present  needs  in  a 
growing  community,  it  represents  a  short-sighted  policy  on  the  part 
of  the  owners.  If  the  owners  are  mistaken  in  their  judgment  as  to 
future  growth  and  needs,  the  penalty  is  sure.  Foreclosure  or  bank- 
ruptcy awaits  upon  failure  or  mistaken  judgment.  But  when  the 
foresight  is  justifiable,  profit  should  not  be  limited  to  the  value  of 
only  so  much  of  the  plant  as  is  necessary  to  supply  the  present  needs 
of  the  community.  There  should  be  some  reward  for  the  risks  taken 
by  those  who  have  undertaken  to  care  for  both  the  future  as  well  as 
the  present  needs  of  the  community. 

66.  The  right  of  the  owners  of  a  utility  to  make  up  losses  in 
building  up  a  business  has  been  recognized.  The  Wisconsin  Com- 
mission, in  fixing  rates  of  charge,  has  allowed  a  utility  to  capitalize 
the  difference  between  the  past  profits  actually  earned,  and  what 
would  have  been  a  reasonable  profit  in  such  past  years  (See  case 
of  Antigo  Water  Company,  decided  August  3,  1909).  This  is  called 
"going  value."  The  same  principle  was,  as  already  stated,  recog- 
nized bv  the  same  Commission  in  the  Madison  case. 


150  DEVELOPMENT  OF  SCIENTIFIC  RATES 

67.  If  a  public  service  company  is  successful,  and  its  business 
prospers,  its  stock  may  command  a  premium  in  the  market.  Its 
stockholders  may  be  able  to  sell  their  stock  at  a  profit.  The  fact 
that  the  stock  is  worth  more  than  par  does  not  prove  that  the  rate 
of  profit  being  earned  by  the  company  is  excessive,  although  sales 
of  stock  may  be  actually  made  by  stockholders  at  the  higher  price, 
thus  indicating  that  new  stockholders  are  satisfied  to  acquire  an 
interest  in  the  investment  at  a  price  which  will  not  net  them  the 
full  profit  being  earned  by  the  stock.  A  sale  of  stock  above  par 
merely  indicates  that  the  purchasing  stockholders  are  satisfied  with 
the  prospects  of  success,  have  confidence  in  the  management  and  in 
the  community  being  served,  and  feel  reasonably  sure  that  they  will 
continue  to  receive  an  acceptable  rate  of  return. 

68.  Independently  of  statute,  a  stockholder  has  a  right  to 
subscribe  for  increased  capital  stock  at  par.  The  statutes  in  some 
states  authorize  the  stockholders  to  fix  the  value  of,  and  the  price 
above  par  at  which,  the  increased  capital  stock  shall  be  subscribed 
and  paid  for  by  the  stockholders.  In  some  states  the  commissions 
have  the  right  to  fix  the  price,  above  par,  at  which  the  stock  of  a 
public  service  corporation  shall  be  sold,  or  to  require  it  to  be  sold 
at  public  auction.  This  authority  was  formerly  exercised  by  the 
Massachusetts  commissions,  which,  in  cases  of  increase  of  capital 
stock,  determine  the  number  of  shares  to  be  sold  and  its  offered 
price.  Under  the  recent  1909  amendment  to  the  Stock  and  Bond 
Law  of  that  State  with  reference  to  gas  and  electric  companies,  the 
price  is  now  in  the  first  instance  fixed  by  the  Board  of  Directors  of 
the  Company,  subject  however  to  the  approval  of  the  Board  of  Gas 
and  Electric  Light  Commissioners. 

69.  Where  a  company  has  gained  such  a  standing  that  its 
subsequent  stock  issues  will  sell  for  more  than  par,  the  right  of  the 
stockholder  to  subscribe  for  such  increased  capital  stock  becomes 
valuable.  If  the  law  does  not  otherwise  provide,  the  original  stock- 
holder has  the  right  to  anticipate  that  if  the  company  is  successful, 
he  will  have  this  right.  If  he  sells  his  stock,  the  purchaser  acquires 
the  right.  If  the  company  is  successful  and  the  right  to  subscribe 
has  value,  it  may  be  considered  a  proper  and  additional  reward  for 
foresight  and  good  management.  It  is  important  that  future  stock 
issues  of  a  growing  company  have  a  ready  market.  Experience 
shows  that  in  order  to  market  bonds,  they  must  ordinarily  be  sold 
at  a  discount,  or  a  bonus  must  be  paid  to  those  who  underwrite 
them,  and  thus  give  them  character  as  a  desirable  investment.   This 


REASONABLE  PROFIT  151 

is  equally  true  of  a  stock  issue,  although  the  law  does  not  contem- 
plate the  issue  of  stock  at  less  than  par.  An  investor  is  more  ready 
to  purchase  a  bond  or  stock  issue  that  has  been  underwritten,  than 
one  that  has  not  been.  The  cost  of  the  guaranty  afforded  by  an 
underwriting  is  everywhere  recognized  as  a  legitimate  item  of  ex- 
pense in  connection  with  such  an  issue.  The  sale  of  stock  to  present 
stockholders  at  a  figure  somewhat  less  than  its  full  market  value 
(where  such  value  is  above  par)  amounts  to  paying  them  the  ex- 
pense which  a  banker's  guaranty  might  cost  the  company. 

70.  As,  however,  a  reasonable  profit  is  that  amount  of  profit 
which  will  bring  to  the  business  freely  the  money  which  it  needs,  it 
would  seem  proper  to  require  increases  of  capital  stock  to  be  sold 
at  market  value.  If  the  issue  price  is  fixed  by  a  commission,  its 
order  should  provide  that  the  stock  be  first  offered  to  present  stock- 
holders at  a  price  which  will  make  it  attractive  to  them,  and  only 
such  stock  as  is  not  so  taken  should  be  ordered  sold  in  the  open 
market.  A  requirement  that  stock  shall  be  sold  in  the  open  market 
in  the  first  instance  introduces  an  element  of  risk,  for  an  unsuccessful 
attempt  to  sell  stock  will  damage  the  company's  credit.  The  course 
referred  to  will  result  in  bringing  the  amount  of  the  stock  premiums 
into  the  business,  instead  of  giving  this  additional  value  to  the  stock- 
holders, in  the  form  of  a  personal  profit.  The  premium  received 
by  the  company  becomes  surplus.  The  new  stock  receives  a  less  net 
dividend  than  the  original  stock,  which  has  carried  the  earlier  risks 
of  the  business,  and  the  value  of  the  original  stock  is  increased. 
The  present  value  of  the  company's  investment  becomes  greater 
than  its  capitalization.  As  the  utility  is  entitled  to  earn  a  reason- 
able rate  of  return  on  the  fair  value  of  its  property,  this  may  result 
in  producing  a  higher  rate  of  return  on  the  actual  capitalization  of 
such  value,  than  on  the  fair  value  itself. 

Ill — Distribution  of  Profit  Between  Stocks  and  Bonds 

71.  Money  invested  in  public  utilities  must  come:  (a)  entirely 
from  the  individual,  or  the  stockholders  of  the  companj^  engaged 
in  the  enterprise;  or  (b)  in  part  from  the  general  investing  public, 
through  the  sale  of  bonds  or  other  evidences  of  indebtedness.  In 
the  former  case,  the  owners  bear  all  the  risks  of  the  business,  and 
in  the  latter  case,  the  indi^ddual  or  the  stockholders  of  a  company, 
must  bear  a  greater  share  of  the  risks  than  do  the  bondholders. 

72.  The  proportion  of  the  risk  borne  by  each  varies  according 
to  the  ratio  which  the  amount  of  bonds  issued  bears  to  the  total 


152  DEVELOPMENT  OF  SCIENTIFIC  RATES 

investment.  If  the  bonds  represent  one-half  of  such  investment, 
the  owner  or  stockholder  bears  a  greater  share  of  the  risks  of  the 
business,  than  if  the  bonds  represent  75%  or  100%  of  the  value  of 
the  property.  It  is  this  element  of  risk  assumed  by  stockholders 
that  makes  a  bond  issue,  which  represents  50%  of  the  value  of  the 
investment,  sell  at  a  higher  rate  than  one  which  represents  a  greater 
percentage.  Ordinarily,  the  greater  the  margin  between  the  amount 
of  bonds  issued  and  the  value  of  the  property  bonded,  and  the  less 
the  risk  assumed  by  the  bonds,  the  lower  the  rate  of  interest  at  which 
such  bonds  can  be  marketed. 

73.  Theoretically  bonds  should  be  sold  at  par,  and  should 
have  such  margin  of  security,  and  bear  such  a  rate  of  interest  as 
will  insure  their  sale  at  par  during  the  construction  period,  within 
which  it  is  expected  to  market  them.  A  seasoned  bond  does  so  sell. 
The  sale  of  bonds  at  less  than  par  may  indicate  one  of  several  con- 
ditions, or  a  combination  of  these  conditions.  The  inherent  risks 
of  the  business  may  be  such  that  capital  can  only  be  brought  into  it 
by  the  prospect  of  large  profit.  It  may  be  that  the  purchaser,  al- 
though believing,  that  when  the  business  is  well  established,  his 
security  will  be  ample,  feels  that  the  risks  of  the  initial  period  of 
development  should  be  represented  by  a  discount  from  the  par  value 
of  the  bonds.  He  may  require  such  a  discount  as  will  offset  the 
fact  that  the  bond  of  a  new  company  is  less  readily  sold,  or  used 
as  collateral,  than  is  the  bond  of  a  company  having  a  well  established 
business.  The  sale  of  bonds  at  less  than  par  may  be  a  concession  to 
the  ordinary  desire  of  the  purchaser  for  a  bargain.  This  human 
element  is  well  recognized  by  bond  dealers,  who  know  it  is  easier  to 
sell  at  a  discount  a  bond  carrying  a  fair  rate  of  interest,  than  to 
obtain  a  premium  for  a  bond  carrying  a  rate  above  the  average. 
Whatever  the  reason,  the  marketing  of  bonds  at  a  discount  is  recog- 
nized by  the  public  and  by  the  commissions  as  a  legitimate  method 
of  providing  capital. 

74.  By  the  sale  of  bonds  below  par,  the  enterprise  is,  however, 
deprived  of  the  use  of  so  much  of  its  capital  as  it  has  been  required 
to  use  for  the  purpose  of  thus  paying  in  advance  a  portion  of  the 
interest  on  its  bonds.  The  enterprise  must  earn  upon  the  value  of 
its  tangible  property,  a  profit  equal  to  the  interest  it  has  agreed  to 
pay  upon  the  face  of  its  bonds,  plus  a  certain  proportion  of  the 
amount  of  the  discount  at  which  they  are  sold.  The  discounts  may, 
on  the  other  hand,  be  capitalized  and  included  in  the  going  value  of 
the  business,  and  if  this  value  is  so  capitalized,  it  must  earn  the 


REASONABLE  PROFIT  153 

same  rate  of  profit  as  the  tangible  property.  The  discounts  on 
bonds  may  be  written  off  in  a  short  period,  as  a  suspense  item,  and 
if  this  course  is  followed  such  amounts  should  not  be  considered 
part  of  the  reasonable  profit,  which  the  utility  is  entitled  to  earn 
upon  the  value  of  its  tangible  property. 

75.  If  the  margin  of  security  for  the  bonds  is  ample,  and  they 
will  not  sell  at  par,  or  subject  to  a  reasonable  discount,  it  indicates 
that  the  interest  rate  is  too  low,  or  that  money  looking  for  invest- 
ment and  otherwise  willing  to  accept  the  rate  of  return  offered, 
considers  the  risk  too  great.  The  element  of  risk  determines  the 
price  at  which  bonds  can  be  sold,  regardless  of  the  security  behind 
them  or  the  rate  of  interest  they  bear.  A  bond  which  must  be  sold 
at  an  unreasonable  discount,  is  clearly  not  bearing  a  rate  of  return 
equal  to  the  risk. 

76.  A  bond  should  not  ordinarily  bear  such  rate  of  interest  as 
will  cause  it  to  sell  for  more  than  par,  although,  of  course,  this  is 
not  a  serious  matter.  The  premium,  however,  arising  from  the  sale 
should  not  be  used  as  a  part  of  the  current  receipts,  but  should  be 
treated  as  capital.  The  rate  of  interest  a  bond  should  bear  will 
necessarily  vary  with  the  character  of  the  business,  its  location,  and 
the  state  of  the  money  market. 

77.  Under  the  "stock  and  bond  laws,"  such  as  are  now  in  force 
in  Massachusetts,  Michigan,  New  York  and  Wisconsin,  bonds  may 
be  issued  by  a  public  utility  only  under  authority  of  a  state  com- 
mission. The  maximum  rate  which  may  be  paid  on  such  bonds  is 
that  fixed  by  the  usury  laws.  These  laws  also  fix  indirectly  the 
discount  at  which  bonds  can  be  sold,  for  the  courts  have  held  that 
bonds  cannot  be  sold  at  a  discount,  which,  when  taken  together 
with  the  interest  rate,  will  amount  to  the  payment  by  the  borrower 
of  more  than  the  lawful  rate  of  interest. 

78.  Under  the  operation  of  these  stock  and  bond  laws,  if  the 
bonds  cannot  be  sold  at  par,  or  subject  to  a  permitted  discount,  in 
accordance  with  the  order  of  the  state  commission,  a  further  appli- 
cation may  be  made  to  the  commission,  and  a  modification  to  its 
order  secured,  increasing  the  rate  of  interest  payable.  In  such  cases, 
the  rate  of  interest,  which  it  is  necessary  to  pay  in  order  to  bring 
the  money  into  the  business  by  the  sale  of  bonds,  may  be  determined 
by  actual  test.  If  the  bonds,  with  a  reasonable  margin  of  security 
behind  them,  cannot  be  sold  within  the  limits  of  the  laws  against 
usury,  it  would  indicate  that  the  enterprise  itself  is  a  failure. 


154  DEVELOPMENT  OF  SCIENTIFIC  RATES 

79.  There  is  ordinarily,  however,  no  such  test  at  hand  in  the 
matter  of  stock  issues.  If  a  company,  which  has  been  regularly 
paying  a  dividend  upon  its  existing  capital  stock,  increases  its  capi- 
tal stock  with  consent  of  the  commission,  those  purchasing  such 
stock  do  so  with  the  expectation  that  the  issue  for  which  they  are 
subscribing  will  continue  to  pay  the  same  rate  of  dividend  as  before. 
If  the  company  has  a  surplus,  this  may  enhance  the  value  of  the 
stock,  but  will  do  so  more  by  way  of  ensuring  a  continuation  of 
such  dividends,  than  by  way  of  expectation  of  a  share  in  the  distribu- 
tion of  this  surplus. 

80.  Capital  stock  can  be  issued  legally  only  at  par,  although 
it  may  be  paid  for  either  in  cash  or  in  property.  If  the  increased 
stock  is  offered  for  cash,  and  cannot  be  sold  at  par,  it  is  an  indication 
that  it  is  not  paying  a  dividend  large  enough  to  attract  investors, 
in  view  of  the  risks  of  the  business.  Of  course,  this  may  also  be 
due  to  other  elements,  for  a  stock  may  be  earning  and  paying  a 
fair  dividend,  and  still  not  be  worth  par.  This  may  be  due  to  the 
fact  that  the  value  of  the  outstanding  stock  has  become  impaired. 
In  such  case,  it  may  be  that  the  order  of  the  Commission,  authoriz- 
ing the  increase  of  stock,  should  require  this  impairment  to  be 
made  good. 

81.  A  company  which  pays  dividends  not  exceeding  the  highest 
contract  rate  of  interest  allowed  by  the  statute  (in  a  state  where  the 
rate  is  limited)  is  clearly  above  criticism  in  so  doing.  If  its  dividends 
are  governed  by  a  Sliding  Scale  plan,  which  lowers  the  price  as  the 
dividends  increase,  they  may,  without  criticism,  be  larger  than  such 
contract  rate  of  interest.  If  the  capitalization  of  the  company  is  not 
equal  to  the  fair  value  of  its  investment,  the  dividends  paid  may 
furnish  no  test  of  the  reasonableness  of  the  profit  thus  distributed 
to  stockholders  In  many  companies,  particularly  in  Massachusetts 
(where  stock  issues  are  frequently  sold  at  a  price  above  par)  the 
capitalization  may  be  much  less  than  the  fair  value  of  the  invest- 
ment, and  a  dividend  apparently  high  may  in  fact  be  very  moderate. 
In  the  case  of  other  companies,  the  capitalization  may  exceed  the 
fair  value  of  the  investment,  and  a  dividend  apparently  reasonable 
may  in  fact  be  unreasonably  high.  The  rate  of  dividends  paid  may 
therefore  not  prove  the  rate  of  profit  earned  by  a  company. 

82.  The  risks  of  the  business  are  such  that  a  company  should 
be  allowed  to  earn  more  than  the  amount  required  to  pay  a  reason- 
able dividend  on  a  fair  value  of  its  investment.     The  company 


REASONABLE  PROFIT  155 

should  be  encouraged  to  create  a  surplus,  which  will  guarantee  the 
credit  and  integrity  of  the  plant  and  the  service  furnished,  insure 
against  contingencies,  and  make  certain  the  continued  payment  of 
dividends.  The  importance  of  creating  a  surplus  is  recognized  by 
the  New  York  Public  Service  Commissions  Act,  Sees.  49  (Common 
Carriers),  72  (Gas  and  Electric  Companies)  and  97  (Telegraph  and 
Telephone  Companies),  as  amended  and  added  to  by  Laws  1910 
(Chapter  480)  in  providing  that,  in  determining  rates,  regard  shall 
be  had  to  a  reasonable  average  return  upon  capital  actually  ex- 
pended, and  to  the  necessity  of  making  reservations  out  of  income 
for  surplus  and  contingencies.  The  accumulation  of  such  a  surplus 
has  been  approved  by  the  Interstate  Commerce  Commission  (In  re 
advances  in  Freight  Rates,  9  I.  C.  C.  Rep.  382,  1903).  Under  the 
laws  of  Ontario,  the  dividends  of  a  public  service  corporation  are 
restricted  by  its  charter,  although  there  is  no  restriction  upon  the 
amount  which  it  is  entitled  to  earn.  Some  of  these  recent  charters 
have  restricted  the  payment  of  dividends  to  ten  per  cent.  In  Eng- 
land, dividends  are  quite  generally  governed  by  a  Sliding  Scale,  and 
are  no  longer  fixed  absolutely.  It  is  of  the  greatest  importance  that 
a  proper  dividend  rate  should  be  sustained,  both  in  order  to  hold 
together  the  present  body  of  stockholders,  and  also  to  make  them 
willing  to  respond  to  new  calls  for  additional  capital  as  required. 
The  rate  of  profit  earned,  however,  should  be  greater  than  the  rate 
of  dividend  declared,  because  of  the  great  value  of  a  continuous 
record  of  dividend  payments. 

83.  The  necessity  of  paying  interest  upon  bonds,  reasonably 
issued,  has  long  been  recognized  by  the  courts.  Recent  decisions, 
and  recent  rulings  of  state  commissions,  have,  however,  recognized 
the  fact  that  stockholders  must  also  be  giveu  their  full  considera- 
tion, as  otherwise  there  exists  an  inducement  to  issue  bonds  rather 
than  stock,  which  would  result  in  subjecting  the  utility  to  the  pay- 
ment of  greater  fixed  charges. 

84.  Under  the  rulings  of  the  New  York  Public  Service  Com- 
mission, Second  District,  the  amount  of  bonds  which  will  be  ap- 
proved by  it  for  issue  by  a  newly  organized  utility,  is  limited  by 
the  amount  of  the  prospective  net  earnings.  No  bond  issue  will  be 
permitted  "creating  an  interest  charge  beyond  an  amount,  which  it 
is  reasonably  certain  can  be  met  from  the  (future)  net  earnings"  of 
the  company  as  estimated  (See  appendix,  ruling  on  application  of 
Rochester-Corning-Elmira  Traction  Company).  Stock  represent- 
ing a  cash  investment  will  be  required  "to  an  amount  suflBcient  to 


156  DEVELOPMENT  OF  SCIENTIFIC  RATES 

afford  a  moral  guaranty,  that  in  the  judgment  of  those  investing, 
the  enterprise  is  likely  to  prove  commercially  successful." 

85.  Rule  XXIV  of  the  Rules  of  Practice  of  this  Commission, 
governing  applications  for  authority  to  issue  stocks,  bonds,  notes  or 
other  evidences  of  indebtedness,  requires  the  petition  to  set  out 
(among  other  things)  in  full,  the  terms  of  any  contract  or  arrange- 
ment to  sell  such  stock,  bonds  and- notes;  if  no  contract  or  arrange- 
ment has  been  made,  there  must  be  a  showing  by  affidavit  of  a 
competent  person  as  to  the  amount  which  can  probably  be  realized 
from  the  sale  or  disposition  thereof,  and  the  reasons  for  such  opinion. 

86.  Professor  Howard  G.  Bronson,  of  the  University  of  Penn- 
sylvania, recently  made  a  detailed  examination  of  the  investment 
and  profits  of  the  Illinois  Central  Railroad  for  the  fifty-eight  (58) 
years  from  1851  to  1909  ("Profits  of  American  Railways  as  Illus- 
trated by  the  Illinois  Central" — Railway  Age  Gazette,  July  1, 
1910).  He  states  that  the  liabilities  of  that  company,  including 
stocks  and  bonds  in  the  hands  of  the  public,  are  less  by  nearly  $45,- 
000,000  than  the  cash  value  of  the  assets  exclusive  of  real  estate 
appreciation.  The  returns  to  stockholders  covering  the  fifty-two 
(52)  year  period  from  1858  to  1909  averaged  9.48%  earned  and 
7.6%  paid  on  cash  actually  invested;  the  difference  resulting  in  an 
accumulated  surplus  of  $50,000,000,  out  of  a  total  of  a  little  over 
$300,000,000.  The  railroad  had  during  this  period  borrowed  money 
at  rates  bearing  from  7%  down  to  4%  (average  about  5%).  The 
share  holders  had  directly  or  indirectly  furnished  over  one-half  of 
the  entire  capital  account. 

87.  In  his  testimony  before  the  Special  Examiners  for  the 
Interstate  Commerce  Commission  at  Chicago  on  August  29,  1910, 
Mr.  E.  P.  Ripley,  President  of  the  Santa  Fe  System,  stated  that  in 
his  opinion  a  railroad  should  earn,  over  and  above  interest  on  bonds 
and  other  capital  liabilities,  not  less  than  12  per  cent,  of  which  not 
less  than  6  per  cent  should  be  paid  in  dividends  to  stockholders,  the 
remaining  6  per  cent  should  be  used  for  improvements  which  would 
earn  no  return,  thus  providing  for  obsolescence  and  depreciation.  In 
his  testimony  before  the  Interstate  Commerce  Commission  at  Wash- 
ington on  October  13,  1910,  Mr.  Daniel  Willard,  President  of  the 
Baltimore  and  Ohio  Railroad,  declared  that  in  his  opinion  a  railroad 
stock  paying  less  than  6  per  cent  was  not  attractive  to  investors. 

88.  The  London  Sliding  Scale  (which  is  much  used  in  England 
in  the  regulation  of  gas  rates  and  to  some  extent  in  the  regulation 


REASONABLE  PROFIT  157 

of  electric  rates)  involves  the  fixing  of  a  standard  dividend  and 
initial  price;  as  the  price  of  gas  or  electricity  is  reduced,  the  allow- 
able dividends  are  increased.  This  standard  dividend  varies  in 
England  from  seven  to  ten  per  cent.  This  principle  has  been 
adopted  in  regulating  the  gas  rates  of  the  Boston  Consolidated  Gas 
Company.  The  Act  (Chapter  422  of  1906)  is  entitled  "An  Act  to 
promote  the  reduction  of  the  price  of  gas  in  the  City  of  Boston,  and 
its  vicinity."  It  fixes  the  initial  price  of  gas  at  ninety  cents  per  M. 
and  the  standard  rate  of  dividends  at  seven  per  cent;  for  each 
reduction  of  one  cent  in  the  price  of  gas,  the  Company  may  increase 
its  dividend  payments  one-fifth  of  one  per  cent. 

The  principle  of  the  Sliding  Scale  as  applicable  to  gas  and  elec- 
trical companies  has  also  been  recognized  by  the  recently  amended 
New  York  Public  Service  Commissions  Law  (Section  72,  1910). 
It  is  also  recognized  by  the  Wisconsin  Public  Utilities  Law,  both  as 
to  the  Company,  its  customers  and  its  employes  (Section  1797m-17). 

89.  The  fact  that  a  utility  has  in  the  past  earned  more  than  a 
reasonable  return  does  not  affect  its  right  to  now  earn  a  reasonable 
rate  of  profit  based  on  present  conditions.  That  large  profits  have 
been  taken  out  of  the  business,  in  the  form  of  dividends  or  other- 
wise, does  not  affect  the  present  value  of  the  property  being  used  in 
the  public  service.  This,  however,  should  not  induce  a  utility  to 
take  advantage  of  a  failure  on  the  part  of  the  public  to  regulate  its 
rates.  It  should  not  seek  to  earn  unreasonable  profits  now,  with 
the  fear  that  hereafter  the  right  to  earn  a  reasonable  profit  will  be 
denied  it.  It  should  treat  the  public  now  with  that  same  spirit  of 
fairness  with  which  it  expects  to  be  treated,  if  its  rates  are  at  any 
time  questioned  by  public  authority. 

90.  A  plant  may  have  been  built  largely  from  earnings  remain- 
ing after  reasonable  profits  have  been  taken  out  of  the  business,  in 
the  form  of  dividends  or  otherwise.  That  fact  is  immaterial,  if 
these  earnings  have  resulted  from  rates  of  charge  which  have  not 
been  exorbitant  or  unreasonable  in  themselves,  for  it  is  clear  that 
the  entire  earnings  might  have  been  taken  out  of  the  business,  and 
the  additional  facilities  provided  for  from  the  sale  of  capital  securi- 
ties. It  is  the  present  fair  value  which  forms  a  basis  for  present 
reasonable  rates.  According  to  modern  ideas,  maintenance  of  prop- 
erty and  depreciation  and  obsolescence  are  strictly  items  of  cost, 
and  must  be  taken  care  of  in  arriving  at  net  earnings.  A  reasonable 
surplus,  over  and  above  reasonable  profit  taken  out  of  net  earnings. 


158  DEVELOPMENT  OF  SCIENTIFIC  RATES 

should  be  retained  and  invested  in  the  plant.  This  additional  in- 
vestment representing  surplus  should  not  be  capitalized.  Its  func- 
tion, according  to  ideas  now  being  generally  adopted,  is  to  serve  as 
a  contingency  reserve  to  provide,  without  impairment  of  capital,  or 
without  interruption  of  established  dividend  payments,  for  extraor- 
dinary happenings  in  the  way  of  unprecedented  damages  to  prop- 
erty or  of  short  depressions  of  business.  The  directors  of  the  com- 
pany hope  that  they  will  not  have  to  deal  with  these  contingencies, 
but  as  wise  men  take  all  precautions  against  them,  it  being  the  part 
of  wisdom  to  have  something  in  hand  wherewith  to  meet  the 
unforeseen. 

Conclusions 

91.  1: — -A  reasonable  profit  is  that  profit  which  will  readily 
bring  needed  money  into  the  business. 

2: — The  reasonable  rate  of  profit  is  not  an  arbitrary  rate,  but 
will  vary  at  different  times  and  in  different  places,  according  to  the 
risks  involved  in  each  particular  enterprise. 

3: — A  rate  of  profit,  which  a  court  may  not  hold  confiscatory, 
may  not  be  a  reasonable  rate.  The  courts  have  avoided  deciding 
what  is  a  reasonable  rate  of  return.  The  question  is  a  legislative 
or  administrative  one.  It  becomes  a  judicial  one  only  when  a  rate 
fixed  is  claimed  to  be  unreasonable. 

4: — The  reasonable  rate  will  be  fixed  by  a  rate-making  body, 
upon  an  investigation  of  the  economics  of  the  particular  situation. 
The  courts  will  not  fix  the  reasonable  rate  of  profit,  even  in  review- 
ing the  action  of  such  bodies.  They  will  merely  afford  redress 
against  an  unreasonably  low  rate  so  fixed. 

5 :— The  reasonable  profit  which  a  utility  is  entitled  to  earn  must 
arise  from  the  operation  of  its  entire  schedule  of  rates.  Under  some 
circumstances,  however,  the  utility  may  have  the  right  to  insist  that 
a  separate  class  or  classes  of  service  carry  a  distinct  reasonable 
return,  and  a  reasonable  return  from  an  entire  schedule  may  not 
excuse  the  lack  of  a  reasonable  return  from  a  particular  schedule. 

6: — The  distribution  of  the  reasonable  profit  over  rates  for 
different  classes  of  service  must  be  done  by  the  utility,  in  the  exer- 
cise of  good  judgment,  so  that  the  resultant  total  profit  will  be 
adequate  and  reasonable. 


REASONABLE  PROFIT  159 

7: — The  reasonable  profit  cannot  be  distributed  by  exact  rule 
over  each  class  of  business.  It  must  be  distributed  according  to  the 
value  of  the  service  to  the  different  classes  of  customers. 

8: — In  distributing  profits  to  investors,  the  proportion  assigned 
to  each  class  (as  stockholders  and  bondholders)  should  bear  a  proper 
relation  to  the  risks  assumed  by  each.  The  interest  paid  on  well 
secured  bonds  should  be  lower  than  the  dividend  paid  to  the  stock- 
holder, who  by  his  investment,  has  guaranteed  the  principal  and 
interest  of  the  bonds,  while  his  own  investment  and  return  are  sub- 
ject to  the  fluctuations  and  risks  of  the  business. 

9: — Initial  or  temporary  risks  assumed  by  investors  may  properly 
be  compensated  for  by  returns  in  a  form  other  than  annual  interest 
or  dividends.  The  investor,  who  buys  the  bonds  of  a  new  com- 
pany at  a  reasonable  discount,  is  entitled  to  the  profit  accruing  by 
the  rise  of  his  bonds  towards  par,  as  the  company's  business  be- 
comes established;  and  original  or  early  stockholders  are  entitled, 
as  a  recompense  for  their  risk  and  enterprise,  to  the  increased  mar- 
ket value  of  their  stock,  and  to  subscribe  for  new  stock  issues  at 
par,  if  this  common  law  right  has  not  been  modified  by  statute. 

10: — The  cost  of  building  up  a  business,  and  acquiring  an  exist- 
ing business  in  order  to  adequately  provide  for  the  public  demands, 
are  elements  of  going  value,  for  which  a  utility  company  is  entitled 
to  credit  in  the  determination  of  its  reasonable  profit.  Such  credit 
may  be  given  it,  either  by  permitting  the  capitalization  of  these 
costs  as  intangible  assets,  or  by  allowing  the  earning  of  temporarily 
increased  returns  to  repay  them. 

11: — The  reasonable  return  should  be  applied  to  the  fair  value 
of  the  property  used  in  serving  the  public,  as  a  unit,  and  without 
regard  to  the  nature  of  the  capitalization  representing  this  value. 
The  fact  that  bonds  may  bear  a  certain  rate  of  interest  should  not 
result  in  restricting  so  much  of  the  value  of  the  plant  to  earning 
this  fixed  charge.  If  the  rate  of  interest  on  bonds  is  less  than  the 
reasonable  return  upon  the  fair  value  of  the  entire  property,  the 
stockholders  are  entitled  to  the  excess  earnings  as  part  of  their  share 
in  the  total  profit. 

l"^: — The  reasonable  return  should  not  be  entirely  taken  out  of 
the  business  in  the  form  of  periodical  dividends  or  otherwise.  A 
surplus  should  remain  to  ensure  the  regular  payment  of  reasonable 
dividends  during  inevitable  periods  of  slack  business.     The  return 


160  DEVELOPMENT  OF  SCIENTIFIC  RATES 

in  years  of  prosperity  should  be  larger  than  the  interest  paid  on 
bonds,  and  the  reasonable  dividends  paid  on  stock. 

13: — A  showing  that  the  owners  of  a  utility  have  in  the  past 
received  more  than  a  reasonable  profit,  does  not  affect  their  right 
to  earn  a  reasonable  profit  now  and  hereafter,  nor  should  a  show- 
ing that  the  investment  represents  in  part  past  earnings,  especially 
if  these  earnings  have  resulted  from  rates  of  charge  not  inherently 
unreasonable. 

14: — If  the  profit  is  to  be  limited  by  law,  economical  operation 
should  be  encouraged  by  providing  for  an  increase  in  the  rate  of 
return,  proportionate  to  the  decrease  in  the  rate  of  charge  for  service. 
A  fair  division  of  benefits  between  the  utility  and  the  public  should 
be  encouraged  by  use  of  the  principle  of  the  Sliding  Scale. 

15:— The  reasonableness  of  the  rate  of  profit  should  be  judged 
in  the  light  of  what  the  utility  has  done  for  the  community.  If  the 
plant  has  been  well  kept  up,  if  the  rates  are  low,  or  have  been 
gradually  lowered,  and  the  public  has  been  given  its  share  of  the 
economies  resulting  from  the  progress  of  the  art,  the  utility  should 
be  entitled  to  an  increased  rate  of  return. 


Appendix 

The  progress  of  the  law  on  the  subject  of  Reasonable  Profit  will 
appear  from  an  examination  of  the  decisions  in  their  chronological 
order.  It  was  in  1876  that  the  United  States  Supreme  Court  de- 
cided the  case  of  Munn  vs.  Illinois  (94  U.  S.  113),  and  held  that  state 
authorities  had  a  right  to  fix  rates  for  a  business  affected  with  a 
public  interest.  The  court  held  that  the  rate  fixed  by  the  state 
authorities  was  absolute  and  final,  and  that  the  courts  could  afford 
no  redress,  if  the  rates  so  fixed  were  unreasonably  low.  Later 
decisions  questioned  the  correctness  of  this  view,  but  it  was  not 
until  1889  in  the  case  of  Chicago,  Milwaukee  and  St.  Paul  Railroad 
Company  vs.  Minnesota  (134  U.  S.  418),  that  this  doctrine  was 
modified,  and  it  was  declared  that  a  rate  fixed  by  a  legislature  or  a 
commission,  if  unreasonable,  was  illegal. 

The  courts  have  felt  their  way  cautiously  in  deciding  cases  in- 
volving the  subject  of  Rate  Regulation  and  Fair  Return.  A  dis- 
tinction was  drawn  in  some  cases  between  rates  fixed  by  a  subordi- 
nate administrative  body,  and  rates  fixed  by  the  legislature  itself. 
In  other  cases,  a  distinction  was  made  between  rates  prescribed  for 
a  corporation  and  those  prescribed  for  an  individual,  and  between 
rates  fixed  for  a  company  engaged  in  a  business  clearly  public,  and 
those  fixed  for  one  engaged  in  a  business  which  had  become  affected 
with  a  public  interest  from  peculiar  circumstances.  These  distinc- 
tions have  since  been  abandoned. 


In  the  earlier  cases,  the  question  before  the  courts  was  whether 
the  right  of  control  existed,  and  not  the  extent  of  the  right.  The 
courts  went  so  far  as  to  hold  that  they  had  no  power  to  inquire  into 
or  interfere  with,  the  question  of  the  unreasonableness  of  a  rate  fixed 
by  the  legislature  or  a  subordinate  or  administrative  body. 

Munn  vs.  Illinois  (1876),  94  U.  S.  113. 

Chicago,  Burlington  and  Quincy  Railroad  Company  vs.  Iowa 

(1876),  94  U.  S.  155. 

Peik  vs.  Chicago  and  Northwestern  Railway  Company  (1876), 
94  U.  S.  164. 


162  DEVELOPMENT  OF  SCIENTIFIC  RATES 

II 

It  was  soon  recognized,  however,  that  there  were  limitations  to 
the  extent  of  the  right  to  regulate.  The  courts  in  the  following 
cases  suggested,  but  did  not  feel  called  upon  to  define  or  apply, 
such  limitations. 

Spring  Valley  Water  Works  vs.  Schottler  (1884),  110  U.  S.  347. 
Railroad  Commission  Cases  (1886),  116  U.  S.  307. 

Ill 

The  doctrine  was  finally  established  that  a  utility  is  entitled  to 
a  reasonable  return  on  the  fair  value  of  its  property  used  in  serving 
the  public,  and  that  a  rate,  which  restricts  a  utility  to  an  unreason- 
ably low  profit,  is  confiscatory  and  void. 

Regan  vs.  Farmers'  Loan  and   Trust  Company   (1893),    154 
U.  S.  362. 

Here  the  Trustee  for  the  second  mortgage  bondholders  of  the 
International  and  Great  Northern  Railroad  Company  filed  its  bill 
to  restrain  the  Texas  Railroad  Commissioners  (Regan  and  others) 
from  enforcing  a  certain  schedule  of  rates  fixed  by  them.  The  pro- 
posed t^^riff  would  so  have  diminished  the  earnings  of  the  railroad, 
that  they  would  not  have  been  sufficient  to  pay  one-half  the  interest 
on  the  bonded  debt  above  operating  expenses.  The  commissioners 
were  enjoined  from  enforcing  the  rates  as  fixed.  The  court  held  that 
it  was  within  its  power  to  decree  such  rates  to  be  unreasonable  and 
to  restrain  their  enforcement;  but  that  it  was  not  within  its  power 
to  establish  rates  itself,  or  to  restrain  the  commission  from  again 
establishing  rates. 

Covington  and  Lexington  Turnpike  Road  Company  vs.  Sand- 
ford  (1896),  164  U.  S.  578. 

This  case  involved  the  validity  of  a  Kentucky  statute  fixing 
turnpike  tolls.  An  action  was  brought  against  the  company  by 
users  of  the  turnpike  to  restrain  it  from  charging  tolls  in  excess  of 
those  fixed  by  the  statute.  The  company's  answer  set  forth  that 
the  reduction  ordered  would  so  diminish  its  income,  that  it  could 
not  maintain  its  road,  meet  its  ordinary  expenses,  and  earn  any 
dividends  whatever  for  its  stockholders.  The  case  was  heard  upon 
the  facts  set  up  in  the  pleadings  and  upon  the  basis  of  this  allega- 


REASONABLE  PROFIT  163 

tion,  the  statute  was  held  invalid,  and  the  judgment  of  the  Ken- 
tucky Court  of  Appeals  was  reversed. 

Xew  Memphis  Gas  and  Light  Company  rs.  City  of  Memphis 
(1896),  72  Federal  952. 

Here  the  taxing  district  of  Memphis  (Tennessee)  had  been 
authorized  by  act  of  the  legislature  to  regulate  gas  prices.  The 
taxing  district  by  ordinance  undertook  to  fix  the  price  at  $1.50  per 
M.  The  company  claimed  that  this  rate  would  not  enable  it  to 
maintain  its  existence,  or  make  a  reasonable  profit  on  the  money 
invested  in  the  enterprise. 

Upon  application  for  a  temporary  injunction,  the  Court  (Dis- 
trict Judge  Clark)  held  that  if  the  company  could  by  proof  sustain 
the  charges  of  the  bill,  the  ordinance  was  illegal,  as  amounting  to  a 
destruction  of  its  property,  and  accordingly  granted  the  injunction. 
The  Court  said:  "The  company  has  a  right  to  such  gross  income 
from  the  sale  of  gas  as  will  enable  it  to  pay  all  legitimate  operating 
expenses,  pay  interest  on  all  valid  fixed  charges,  so  far  as  bonds  or 
securities  represent  an  expenditure  actually  made  in  good  faith,  and 
also  to  pay  a  reasonable  dividend  on  stock,  so  far  as  this  repre- 
sents an  actual  investment  in  the  enterprise.  All  of  these  items  and 
perhaps  others,  must  be  taken  into  account,  in  any  regulation  which 
may  be  made  in  respect  to  the  prices  of  gas."  * 

Southern  Pacific  Company  rs,  California  Board  of  Railroad 
Commissioners  (1896),  78  Federal  236. 

Here  an  action  was  brought  to  enjoin  the  Railroad  Commis- 
sioners from  enforcing  a  certain  resolution  reducing  certain  rates, 
including  rates  on  grain.  The  Court  (Circuit  Judge,  afterwards 
Justice  McKenna),  in  granting  a  temporary  injunction,  held  that  the 
right  of  the  State  to  regulate  stopped  at  injustice,  and  that  rates 
were  not  alone  unreasonable  when  they  amounted  to  practical  con- 
fiscation, nor  necessarily  reasonable  when  they  allowed  some  divi- 
dend, however  small,  but  that  a  railroad  company  was  entitled  to  be 
reimbursed  its  charges  and  expenses,  and  to  receive  besides  an  ade- 
quate return  on  investment. 

Smyth,  Attorney-General,  vs.  Ames  (1898),  169  U.  S.  466. 

This  case  is  still  the  leading  one  upon  the  subject  of  rate  regula- 
tion. In  this  case,  the  court  was  called  upon  to  determine  the 
validity  of  a  Nebraska  Act,  fixing  maximum  freight  rates.     The 


164  DEVELOPMENT  OF  SCIENTIFIC  RATES 

rates  fixed  were  such  that  some  of  the  railroads  involved  would 
under  them  earn  on  their  local  business  only  a  little  more  than  their 
operating  expenses,  while  others  would  conduct  their  business  at  a 
loss. 

The  Court  over-ruled  the  argument  of  counsel  for  the  State 
(Messrs.  John  L.  Webster  and  William  J.  Bryan)  that  the  State 
could  require  the  carriers  to  conduct  their  local  freight  business  at  a 
loss,  if  they  earned  on  their  interstate  business  enough  to  give  them 
just  compensation  on  all  their  business  both  interstate  and  domestic. 
The  Court  held  that  domestic  business  should  not  be  made  to  bear 
the  loss  upon  interstate  business,  nor  the  latter  upon  domestic  busi- 
ness. The  Court,  in  holding  the  statute  invalid  as  confiscatory, 
was  not  called  upon  to  say  what  was  a  reasonable  rate  of  profit,  the 
reductions  made  by  the  State  Statute  being  such  as  to  result,  in  the 
case  of  most  of  the  companies  involved,  in  no  profit  at  all,  while  in 
the  case  of  two  of  them,  they  permitted  but  little  more  than  oper- 
ating expenses. 

In  its  opinion  the  Court  used  the  following  language  upon  the 
subject  of  "Valuation  and  Reasonable  Return": 

"If  a  railroad  corporation  has  bonded  its  property  for  an  amount  that 
exceeds  its  fair  value,  or  if  its  capitalization  is  largely  fictitious,  it  may  not 
impose  upon  the  public  the  burden  of  such  increased  rates  as  may  be  re- 
quired for  the  purpose  of  realizing  profits  upon  such  excessive  valuation  or 
fictitious  capitalization;  and  the  apparent  value  of  the  property  and  fran- 
chises used  by  the  corporation,  as  represented  by  its  stock,  bonds,  and 
obligations,  is  not  alone  to  be  considered  when  determining  the  rates  that 
may  be  reasonably  charged.  What  was  said  in  Covington  and  Lexington 
Turnpike  Road  Company  vs.  Sandford,  164  U.  S.  578,  596,  597,  is  pertinent 
to  the  question  under  consideration.  It  was  there  observed:  'It  cannot 
be  said  that  a  corporation  is  entitled,  as  of  right,  and  without  reference  to 
the  interests  of  the  public,  to  realize  a  given  per  cent  upon  its  capital  stock. 
When  the  question  arises  whether  the  Legislature  has  exceeded  its  con- 
stitutional power  in  prescribing  rates  to  be  charged  by  a  corporation  con- 
trolling a  public  highway,  stockholders  are  not  the  only  persons  whose 
rights  or  interests  are  to  be  considered.  The  rights  of  the  pub'ic  are 
not  to  be  ignored.  It  is  alleged  here  that  the  rates  prescribed  are  un- 
reasonable and  unjust  to  the  company  and  its  stockholders.  But 
that   involves  an    inquiry    as    to    what    is    reasonable    and   just  for   the 

public The   public   cannot   properly   be   subjected   to   unreasonable 

rates,  in  order  simply  that  stockholders  may  earn  dividends.  The  Legis- 
lature has  the  authority,  in  every  case,  where  its  power  has  not  been  re- 
strained by  contract,  to  proceed  upon  the  ground  that  the  public  may  not 
rightfully  be  required  to  submit  to  unreasonable  exactions  for  the  use 
of  a  public  highway,  established  and  maintained  under  legislative  authority. 


REASONABLE  PROFIT  165 

If  a  corporation  cannot  maintain  such  a  highway  and  earn  dividends  for 
stockholders,  it  is  a  misfortune  for  it  and  them  which  the  constitution  does 
not  require  to  be  remedied  by  imposing  unjust  burdens  upon  the  public. 
So  that  the  right  of  the  public  to  use  the  defendant's  turnpike  upon  pay- 
ment of  such  tolls  as  in  view  of  the  nature  and  value  of  the  services  rendered 
by  the  company  are  reasonable,  is  an  element  in  the  general  inquiry,whether 
the  rates  established  by  law  are  unjust  and  unreasonable. ' 

'A  corporation  maintaining  a  public  highway,  although  it  owns  the 
property  it  employs  for  accomplishing  public  objects,  must  be  held  to  have 
accepted  its  rights,  privileges,  and  franchises  subject  to  the  condition  that 
the  government  creating  it,  or  the  government  within  whose  limits  it 
conducts  its  business,  may  by  legislation  protect  the  people  against  un- 
reasonable charges  for  the  services  rendered  by  it.  It  cannot  be  assumed 
that  any  railroad  corporation  accepting  franchises,  rights,  and  privileges, 
at  the  hands  of  the  public,  ever  supposed  that  it  acquired  or  that  it  was 
intended  to  grant  to  it,  the  power  to  construct  and  maintain  a  public 
highway  simply  for  its  benefit,  without  regard  to  the  rights  of  the  public. 
But  it  is  equally  true  that  the  corporation  performing  such  public  services 
and  the  people  financially  interested  in  its  business  and  affairs  have  rights 
that  may  not  be  invaded  by  legislative  enactment  in  disregard  of  the 
fundamental  guarantees  for  the  protection  of  property.  The  corporation 
may  not  be  required  to  use  its  property  for  the  benefit  of  the  public  without 
receiving  just  compensation  for  the  services  rendered  by  it.  How  such 
compensation  may  be  ascertained,  and  what  are  the  necessary  elements 
in  such  an  inquiry,  will  always  be  an  embarrassing  question.  As  said  in  the 
case  last  cited:  'Each  case  must  depend  upon  its  special  facts;  and  when  a 
court,  without  assuming  itself  to  prescribe  rates,  is  required  to  determine 
whether  the  rates  prescribed  by  the  Legislature  for  a  corporation  controlling 
a  public  highway  are,  as  an  entirety,  so  unjust  as  to  destroy  the  value  of 
its  property'  for  all  the  purposes  for  which  it  was  acquired,  its  duty  is  to 
take  into  consideration  the  interests  both  of  the  public  and  of  the  owner 
of  the  property,  together  with  all  other  circumstances  that  are  fairly  to  be 
considered  in  determining  whether  the  Legislature  has,  under  the  guise  of 
regulating   rates,   exceeded   its   constitutional   authority,   and   practically 

deprived  the    owner  of    property  without    due  process  of   law The 

utmost  that  any  corporation  operating  a  public  highway  can  rightfully 
demand  at  the  hands  of  the  Legislature,  when  exerting  its  general  powers, 
is  that  it  receive  what,  under  all  the  circumstances,  is  such  compensation, 
for  the  use  of  its  property  as  will  be  just  both  to  it  and  to  the  public' 

"We  hold,  however,  that  the  basis  of  all  calculations  as  to  the  reasonable- 
ness of  rates  to  be  charged  by  a  corporation  maintaining  a  highway  under 
legislative  sanction  must  be  the  fair  value  of  the  property  being  used  by  it 
for  the  convenience  of  the  public.  And  in  order  to  ascertain  that  value,  the 
original  cost  of  construction,  the  amount  expended  in  permanent  improve- 
ments, the  amount  and  market  value  of  its  bonds  and  stock,  the  present  as 
compared  with  the  original  cost  of  construction,  the  probable  earning 
capacity  of  the  property  under  particular  rates  prescribed  by  statute,  and 
the  sum  required  to  meet  operating  expenses,  are  all  matters  for  considera- 
tion, and  are  to  be  given  such  weight  as  may  be  just  and  right  in  each  case. 


166  DEVELOPMENT  OF  SCIENTIFIC  RATES 

We  do  not  say  that  there  may  not  be  other  matters  to  be  regarded  in 
estimating  the  value  of  the  property.  What  the  coinpany  is  entitled  to 
ask  is  a  fair  return  upon  the  value  of  that  which  it  employs  for  the  public 
convenience.  On  the  other  hand,  what  the  public  is  entitled  to  demand 
is  that  no  more  be  exacted  from  it  for  the  use  of  a  public  highway  than 
the  services  rendered  by  it  are  reasonably  worth." 

San  Diego  Land  and  Town  Company  vs.  Jasper  (1903),  189 
U.  S.  439. 

Here  the  Board  of  Supervisors  of  San  Diego  (California)  and 
other  counties  had  fixed  maximum  water  rates  allowing  six  per  cent 
(the  minimum  statutory  rate)  upon  the  value  of  the  plant.  The 
valuation  of  the  plant  was  attacked  as  too  low.  The  evidence  on 
this  question  being  conflicting,  the  court  refused  to  interfere. 

Stanislaus  County  vs.  San  Joaquin  and  King's  River   Canal 
and  Irrigation  Company  (1904),  192  U.  S.  201. 

The  facts  and  the  holding  in  this  case  on  the  subject  of  reason- 
able return,  were  similar  to  the  foregoing  case,  a  six  per  cent  return 
(the  minimum  statutory  rate)  having  been  allowed. 

Minneapolis  and  St.  Louis  Railroad  Company  vs.  Minnesota 
(1901),  186  U.  S.  257. 

Here  the  Minnesota  Railroad  and  Warehouse  Commission  had 
fixed  rates  for  coal  in  carload  lots.  The  court  held  that  the  fact 
that  this  rate,  if  applied  to  all  freight,  would  not  enable  the  road  to 
pay  its  operating  expenses,  did  not  operate  to  make  it  confiscatory. 
It  was  also  held  that  companies  were  not  entitled  to  earn  the  same 
percentage  of  profit  upon  all  classes  of  freight  carried.  As  it  did 
not  appear  that  this  rate  would  seriously  impair  the  company's 
profits  from  its  entire  schedule,  the  court  declined  to  interfere. 
(Same  case  80  Minn.,  191,  1900,  affirmed.) 

City  of  Knoxville  vs.  Knoxville  Water  Company  (1909),  212 
U.  S.  1. 

This  was  an  action  by  the  company  against  the  city  to  restrain 
the  enforcement  of  an  ordinance  fixing  maximum  water  rates.  The 
master's  report,  confirmed  by  the  trial  court,  found  that  the  rates 
as  fixed  did  not  permit  a  return  of  six  per  cent,  which  was  the 
minimum  net  return  which  the  company  was  entitled  to  earn,  and 
the  enforcement  of  the  ordinance  was  enjoined  as  confiscatory.  The 
City  of  Knoxville  appealed.     The  Supreme  Court  held  that  there 


REASONABLE  PROFIT  167 

was  error  in  the  appraisement  of  the  value  of  the  company's  plant, 
and  in  other  material  respects,  and  reversed  the  case. 

On  the  subject  of  reasonable  profit,  the  Court  held  (p.  17)  that 
under  any  aspect  of  the  evidence  the  company  was  certain  to  obtain 
a  substantial  net  revenue  under  the  operation  of  the  ordinance;  that 
the  net  income  n  any  event,  would  be  substantially  6%,  or  4% 
after  an  allowance  of  2%  for  depreciation;  that  it  could  not  know 
clearly  that  the  revenue  would  not  much  exceed  that  return.  The 
Court  said:  "We  do  not  feel  called  upon  to  determine  whether  a 
demonstrated  reduction  of  income  to  that  point  would  or  would 
not  amount  to  confiscation."  The  results  being  speculative,  the 
case  was  reversed,  with  instructions  to  the  trial  court  to  dismiss 
the  bill  without  prejudice. 

Wilcox  vs.  Consolidated  Gas  Company  (1909),  212  U.  S.  19. 

This  is  the  most  recent  case  on  the  subject  under  discussion. 
The  facts  are  referred  to  in  the  foregoing  paper  (Par.  20).  The 
ruling  of  the  court  upon  the  subject  of  reasonable  profit  is  quoted 
fully  below  (Appendix  p.  168). 

IV 

In  the  course  of  deciding  the  foregoing  cases,  the  courts  oc- 
casionally reverted  to  the  earlier  doctrine  of  Munn  vs.  Illinois 
(1876),  and  held  that  they  had  no  power  to  interfere  with  a  rate 
fixed  by  the  Legislature. 

Dotv  vs.  Beidelman  (1888),  125  U.  S.  680. 

Biidd  vs.  Xew  York  (1891),  143  U.  S.  517  {Three  Justices 
dissenting) . 

Since  the  decision  in  Smyth  vs.  Ames  (1898),  169  U.  S.  466, 
the  doctrine  has  been  settled  that  an  unreasonably  low  rate  is  con- 
fiscation; and  may  be  so  declared  by  the  courts. 

St.  Louis  and  San  Francisco  Railroad  Company  vs.  Hadley, 
Attorney-GeneraU  et  al.  {Marchy  1909),  168  Federal  317 
{U.  S.  Circuit  Court,  Missouri). 

Here  18  railroad  companies  instituted  proceedings  against  the 
Attorney-General  of  Missouri,  and  the  State  Railroad  Commission- 
ers to  enjoin,  as  confiscatory,  the  enforcement  of  the  1907  statute 


168  DEVELOPMENT  OF  SCIENTIFIC  RATES 

providing  for  a  2c  per  mile  passenger  rate.  Under  the  operation  of 
this  law,  allowing  nothing  for  extra  cost  over  interstate  business, 
the  passenger  earnings  from  state  business  alone  gave  no  return 
whatever  to  three  roads,  and  gave  returns  varying  from  two  to 
between  four  and  five  per  cent  to  others.  If  the  exact  cost  of  service 
was  allowed,  there  would  be  no  earnings  over  expenses.  The  Court 
(District  Judge  McPherson)  entered  a  decree  for  complainants, 
holding  that  the  operation  of  the  law  was  confiscatory  under  the 
a,uthority  of  the  Consolidated  Gas  Company  case.  In  his  opinion, 
the  Court  said:  "The  Supreme  Court  during  the  present  year,  in  the 
case  of  the  City  of  New  York  vs.  Consolidated  Gas  Company  of 
New  York,  212  U.  S.  19,  decided  that  6%  was  fair  and  right  to 
be  given  to  the  owners  upon  the  true  valuation.  My  opinion  is 
that,  while  a  gas  plant  is  in  some  respects  different  from  a  railroad, 
a  railroad  property,  properly  built  and  properly  managed,  should 
over  and  above  expenses,  make  a  return  of  6%  per  annum,  and  con- 
sidering all  the  evidence,  the  evidence  fairly  shows  that  all  of  these 
roads  were  properly  and  economically  built  and  are  being  properly 
and  economically  managed,  and  that,  after  paying  the  expenses  for 
maintenance  and  operation,  there  is  less  than  6%  of  returns,  and 
not  more  than  3%  upon  any  of  them,  and  as  to  some  of  them  a 
deficit,  taking  the  property  as  above  stated  within  the  state  of  Mis- 
souri at  its  fair  valuation.  And  this  is  so  without  reference  to  bonds, 
because  in  no  case  do  the  bonds  bear  6%  interest.  But  taking  the 
business  into  consideration,  there  is  still  not  to  exceed  3%  returns, 
and  in  many  cases  a  deficit,  after  considering  all  debits  and  credits, 
upon  the  true  valuation  for  the  state  business. 

Missouri,  K.  and  T.  Ry.  Co.  vs.  Interstate  Com.  Commission 
{October,  1908),  164  Federal  645. 

Spring  Valley  Water  Company  vs.  City  and  County  of  San 
Francisco  (1903),  124  Fed.  574. 

This  was  an  application  for  a  preliminary  injunction  against 
the  enforcement  of  water  rates  fixed  by  the  Board  of  Supervisors 
of  the  City  and  County  of  San  Francisco.  The  Court  (Circuit 
Judge  Morrow)  held  that  a  return  of  4.4%  on  the  value  of  the 
company's  property  necessarily  employed  in  the  service,  or  3.3% 
on  its  stock,  was  not  a  reasonable  and  just  return,  and  the  prelimi- 
nary injunction  applied  for  was  issued. 


REASONABLE  PROFIT  169 

Spring  Valley  Water  Company  vs.  City  and  County  of  San 
Francisco  (1904),  165  Fed.  657. 

This  was  also  an  application  for  a  preliminary  injunction  against 
the  enforcement  of  water  rates  fixed  by  the  Board  of  Supervisors 
of  the  City  and  County  of  San  Francisco.  A  showing  was  made 
that  under  the  rates  as  fixed,  the  company  could  not  make  more  than 
4.4%  on  the  value  of  its  property.  This  rate  was  held  to  be  un- 
reasonably low  and  confiscatory,  and  the  preliminary  injunction 
was  allowed  (by  Circuit  Judge  Gilbert). 

Spring  Valley  Water  Company  vs.  City  and  County  of  San 
Francisco  (1908),  165  Fed.  667. 

This  was  also  an  application  for  a  preliminary  injunction.  The 
Court  (District  Judge  Farrington)  held  that  rates  of  charge  fixed 
for  a  water  company  which  would  enable  it  to  earn  an  income  of 
five  per  cent  on  the  value  of  its  property  after  all  taxes,  operating 
expenses  and  other  legitimate  and  proper  charges  (including  depre- 
ciation) were  deducted  from  the  gross  income,  were  not  unreason- 
able nor  confiscatory.  It  not  being  clear,  however,  that  the  rates 
would  afford  this  return,  a  preliminary  injunction  was  issued,  all 
compensation  for  water  collected  in  excess  of  the  ordinance  rates 
to  be  impounded  to  await  the  final  decision  of  the  Court. 

In  discussing  the  question  of  reasonable  return,  the  Court  said 

(page  680) : 

"The  utility  is  entitled  to  a  fair  return,  not  always  upon  the  cost  of 
the  property,  because  it  may  have  cost  too  much;  not  always  upon  the 
outstanding  indebtedness,  because  it  may  be  in  excess  of  the  real  value 
of  the  property;  not  always  upon  the  total  amount  invested,  because  some 
portion  of  that  which  is  acquired  by  the  investment  may  be  neither  neces- 
sary nor  presently  useful  for  the  public  service;  but  upon  the  fair  present 
value  of  that  which  is  used  for  the  public  benefit,  having  due  regard  always 
to  the  reasonable  value  of  the  service  rendered.  Each  case  must  depend 
very  largely  upon  its  own  special  facts,  and  every  element  and  every 
circumstance  which  increases  or  depreciates  the  value  of  the  property, 
or  of  the  service  rendered,  should  be  given  due  consideration  and  allowed 
that  weight  to  which  it  is  entitled.  It  is,  after  all,  very  much  a  question  of 
sound  and  well  instructed  judgment." 


State  Court  Decisions 

Brymer  vs.  Butler  Water  Company  (1897),  179  Pa.  St.  231. 

Here  the  Court  held  that  a  water  company  was  entitled  to  a 
rate  of  return,  if  its  property  would  earn  it,  not  less  than  the  legal 
rate  of  interest;  and  that  a  system  of  charges  that  yielded  no  more 
income  than  was  fairly  required  to  maintain  the  plant,  pay  fixed 
charges  and  operating  expenses,  provide  a  suitable  sinking  fund 
for  the  payment  of  debts,  and  pay  a  fair  profit  to  the  owners  of  the 
property  could  not  be  said  to  be  unreasonable. 

Steenerson  vs.  Great  Northern  Ry.  Co.  (1897),  69  Minnesota 
353. 

Here  the  Minnesota  Railroad  and  Warehouse  Commission  fixed 
certain  rates  for  the  carrying  of  grain.  The  railroad  company  ap- 
pealed from  this  order  to  the  district  Court,  which  reversed  the  order 
of  the  Commission,  which  order  was  in  turn  reversed  by  the  Supreme 
Court.  The  Court  held  that  under  the  circumstances  of  the  case, 
a  net  income  of  5%  on  the  cost  of  reproducing  the  road  proper,  and 
a  net  income  of  2.5%  on  the  cost  of  reproducing  terminals  was  not 
unreasonable. 

State  vs.  Minneapolis  and  St.  Louis  Railroad  Company  (1900), 
80  Minn.  191,  affirmed  186  U.  S.  257. 

San  Diego  Water  Company  vs.  San  Diego  (1897),  118  Cal.  556. 

This  was  an  action  to  annul  an  ordinance  fixing  water  rates,  and 
to  enjoin  its  enforcement.  The  trial  Court  held  the  ordinance  void, 
but  on  account  of  errors  the  Supreme  Court  reversed  this  ruling. 
The  majority  of  the  Court  held  that  the  Company  was  entitled  to  a 
net  compensation  at  least  equal  to  the  lowest  current  rate  of  interest 
on  the  basic  value  of  its  plant,  properly  ascertained.  The  minority 
held  the  Court  had  no  power  to  fix  any  limit  of  just  compensation, 
but  only  to  inquire  whether  some  compensation,  however  small,  had 
been  allowed,  and  that  the  extent  of  this  compensation  was  for  the 
municipal  body  to  determine. 


REASONABLE  PROFIT  171 

City  of  Grand  Haven  vs.   Grand  Haven  Waterworks  (1899), 
119  Michigan  652. 

Here  a  pumping  contract  had  been  rescinded  by  the  Court  (99 
Mich.  106)  and  an  accounting  ordered  as  to  the  amount  which  the 
city  should  equitably  be  required  to  pay  for  hydrant  service.  In  the 
absence  of  better  data  for  measuring  the  compensation,  the  city  was 
charged  with  interest  and  depreciation,  at  the  rate  of  8%,  upon  the 
cost  to  it  of  a  plant  of  its  own. 

Cedar  Rapids  Water  Company  vs.  City  of  Cedar  Rapids  (1902), 
118  Iowa  234. 

Here  the  City  of  Cedar  Rapids  undertook  to  fix  water  rates 
after  the  term  of  the  company's  franchise  had  expired.  These 
rates  were  claimed  by  the  company  to  be  unreasonably  low,  and  an 
action  was  brought  to  restrain  their  enforcement.  The  Court  de- 
clined to  interfere,  as  it  appeared  that  the  net  earnings  of  the  Com- 
pany under  the  rates  fixed  by  the  city  would  amount  to  between 
4  2-5%  and  5/^  on  the  value  of  its  property  or  6.5  on  its  total 
capital  stock  and  bonds. 

City  of  Chicago  vs.  Rogers  Park  Water  Company  (1905),  214 
///.  212. 

Here  a  city  ordinance  requiring  the  water  company  to  furnish 
water  free  to  those  classes  of  consumers  to  which  the  city  water- 
works gave  free  service,  was  held  void. 

Long  Branch  Commission  vs.  Tintern  Manor  Water  Company 
(Nov.,  1905),  70  ;V.  J.  Eq.  71.     Affirmed  71  .V.  J.  Eq.  790. 

Here  the  municipality  filed  its  bill  to  enjoin  the  water  company 
from  discontinuing  its  service.  At  the  hearing  upon  the  question 
of  issuing  a  temporary  injunction,  it  was  agreed  in  open  court  (p. 
74)  that  the  bill  should  be  amended  by  inserting  a  clause  asking  the 
Court  to  determine  the  question  of  the  reasonableness  of  the  Com- 
pany's rates.  This  amendment  was  made,  both  parties  submitted 
themselves  to  the  jurisdiction  of  the  Court,  and  testimony  was  taken, 
and  rates  fixed  by  the  Court's  order. 

The  Court  ruled  the  water  company  was  entitled  to  charge  rates 
which  would  enable  it  to  derive  a  fair  income,  based  on  the  fair 
value  of  its  property  at  the  time  it  was  being  used  by  the  public, 
taking  into  account  the  cost  of  maintenance  and  depreciation,  cur- 
rent operating  expenses  and  the  right  of  the  public  to  have  no  more 


172  DEVELOPMENT  OF  SCIENTIFIC  RATES 

exacted  than  the  service  in  itself  was  reasonably  worth,  including  a 
fair  income  to  the  stockholders  on  their  investment.  The  Court 
approved  the  rulings  in  Brymer  vs.  Butler  Water  Company  (cited 
above)  and  Kennebec  Water  District  vs.  Waterville,  97  Maine  185, 
and,  in  applying  the  above  rules,  fixed  rates  which  would  allow 
the  company  5%  on  the  value  of  that  portion  of  its  property  used 
in  serving  Long  Branch,  or  4%  free  of  taxation,  or  between  4%  and 
5%  without  allowing  anything  for  depreciation.  The  Court  said: 
"It  is  quite  manifest  that  the  defendant  (company)  will  not,  under 
the  rates  which  I  have  approved,  receive  anything  more  than  a  fair 
income  on  its  property,  even  if  the  value  of  the  works  should  be 
reduced  considerably  below  the  figure  at  which  I  have  placed  them." 

Southern  Indiana  Railway  Company  vs.  Railroad  Commission 
of  Indiana,  87  Northeastern  (Indiana,  April,  1909)  966. 

Here  an  action  was  brought  by  the  commission  to  enjoin  the 
railroad  companies  from  charging  a  rate  in  excess  of  that  fixed  by 
its  order.  The  Court  held  that  the  rate  of  profit  which  the  Company 
was  entitled  to  earn  must  be  determined  from  the  facts  in  each  case. 
The  Court  held  that  the  order  was  not  subject  to  any  constitutional 
objections  and  sustained  it. 

Cedar  Rapids  Gaslight  Company  vs.  City  of  Cedar  Rapids,  120 
Northwestern  966  (Iowa,  May,  1909). 

Here  an  action  was  brought  to  enjoin  the  enforcement  of  a  city 
ordinance  fixing  gas  rates.  The  Court  held  that  a  public  service 
corporation  was  entitled  to  earn  enough,  not  only  to  meet  the  ex- 
penses of  current  repairs,  but  to  provide  means  for  replacing  parts 
of  the  plant  when  the  same  could  no  longer  be  used,  so  that  at  the 
end  of  any  given  term  of  years,  the  original  investment  would  re- 
main as  it  was  at  the  beginning.  The  Court  further  stated  that  it 
could  not  say  that  the  income  of  such  a  corporation  must  necessarily 
exceed  5%  above  expenses,  including  taxes  to  avoid  the  charge  of 
being  discriminatory.  The  Court  said:  "As  the  rates  fixed  by  the 
ordinance  are  likely  to  yield  enough  above  6%  per  annum  on  the 
present  value  of  the  plant  to  cover  contingencies,  which  may  not 
have  been  taken  into  account,  and  in  view  of  the  fact  that  effect  of 
the  ordinance  is  largely  speculative,  we  are  not  inclined  to  interfere 
with  its  operation."  Accordingly  the  petition  was  dismissed  with- 
out prejudice. 


REASONABLE  PROFIT  173 

Coal  and  Coke  Railway  Company  vs.  Conley,  Atty.-Gen.,  67 
Southeastern  613  {West  Va.,  March,  1910). 

Here  the  Company  filed  its  bill  to  enjoin  the  enforcement  of  an 
Act  of  the  West  Virginia  Legislature  regulating  passenger  rates. 
The  proofs  showed  (p.  644)  that  under  such  rates,  the  company 
would  earn  practically  nothing  on  its  passenger  traffic,  and  less  than 
2.0%  on  its  investment  on  its  entire  traffic. 

•  The  Court  held  that  ordinarily  the  rate  of  return  generally  re- 
alized upon  similar  investments  was  deemed  reasonable  and  fair 
and  guaranteed  to  the  investor  in  a  public  utility  if  he  can  earn  it; 
that  the  rate  is  to  be  allowed  upon  the  amount  actually  invested  in 
good  faith,  fictitious  valuations,  indicated  by  overissues  of  stocks  and 
bonds  not  representing  actual  money,  being  rejected;  that  under 
exceptional  and  peculiar  circumstances,  what  would  ordinarily  be 
a  reasonable  rate  of  profit  on  the  entire  investment  may  be  disal- 
lowed, as  being  more  than  the  service  is  worth  to  the  public. 

The  Court  held  further  that  the  fact  that  a  new  railroad  has 
been  built  without  expectation  of  an  immediate  realization  of  a  fair 
profit  on  the  investment  was  not  a  circumstance  justifying  a  disal- 
lowance of  such  return,  if  it  could  be  earned  without  exaction  of  un- 
reasonable rates;  and  that  earnings,  applied  to  the  purchase  of  ad- 
ditional equipment,  extensions  and  improvements  must  be  regarded 
as  part  of  the  net  earnings  upon  an  inquiry  as  to  whether  a  rate 
statute  is  confiscatory.  The  Court  held  further  that  stockholders 
were  entitled  to  equal  consideration  with  bondholders,  there  being 
no  reason  for  a  difference,  because  the  investment  is  represented  by 
one  form  of  security  rather  than  another. 

The  statute  was  declared  confiscatory  as  applied  to  complainant 
and  its  enforcement  enjoined  until  such  time  as  it  should  be  made  to 
appear  that  its  operation  was  no  longer  confiscatory. 


Regulation  of  a  Particular  Class  Rate 

As  to  the  effect  of  a  regulation  of  rates,  the  result  of  the  enforce- 
ment of  which  will  be  to  compel  the  utility  to  serve  for  a  wholly 
inadequate  compensation  a  class  or  classes  selected  for  favor,  even 
if,  considering  the  rates  as  a  whole,  a  reasonable  return  from  opera- 
tions may  be  received.     See 

Atlantic  Coast  Line  vs.  North  Carolina  Corporation  Commis- 
sion (1907),  206  U.  S.  1. 

(Case  involving  an  order  requiring  a  railroad  company  to  re- 
arrange its  schedule  so  as  to  make  connections  with  through  trains, 
when  the  running  of  the  train  required  would  impose  a  pecuniary 
loss  on  the  company.) 

State  of  North  Dakota,  Ex.  Rel.  McCue,  vs.  Northern  Pacific 
Railway  Company  {N.  D.),  25  L.  R.  A.  (N.  S.)  1001 
{April,  1909). 

Here  proceedings  were  instituted  by  the  Attorney-General  to 
enforce  the  provisions  of  the  North  Dakota  Statute  establishing 
maximum  coal  rates  for  the  transportation  by  common  carriers  of 
car  load  lots  of  coal  within  the  State.  The  Statute  was  not  confined 
to  fixing  rates  for  the  transportation  of  lignite  coal,  but  the  coal 
carried  being  chiefly  of  that  description,  the  defendant  claimed  that 
the  test,  as  to  the  reasonableness  of  the  rates  fixed  for  the  transpor- 
tation of  such  coal,  was  whether  the  freight  receipts  derived  from 
hauling  it  between  points  in  North  Dakota  were  sufficient  to  pay,  in 
addition  to  the  operating  expenses  of  this  particular  traffic,  a  reason- 
able compensation  or  profit. 

The  proof  showed  that  the  lignite  coal  shipments  formed  an  in- 
finitesimal portion  of  the  entire  freight  shipments  in  the  State,  and 
hence  that  the  loss  on  freight  receipts,  based  upon  the  rates  sought 
to  be  enforced,  would  not  materially  affect  the  total  receipts  from 
all  freight  shipments  within  the  State.  The  proof  did  not  therefore 
overcome  the  presumption  that  the  statutory  rates  were  reasonable 
and  valid. 

The  Court  held  that  the  proper  test  as  to  whether  the  rates  were 
reasonable  or  unreasonable  was  not  whether  the  rate  fixed  on  the 


REASONABLE  PROFIT  175 

particular  commodity  was  sufficiently  high  to  enable  the  carrier  to 
earn  a  fair  compensation,  after  allowing  for  the  legitimate  cost  of 
transporting  the  same,  but  whether  under  such  rates  the  carrier 
would  be  enabled  from  its  total  freight  receipts  on  all  its  interstate 
traffic  to  earn  a  sum,  above  operating  expenses  reasonably  neces- 
sary for  such  traffic,  sufficient  to  yield  a  fair  and  reasonable  profit 
upon  its  investment,  and  that  it  was  within  the  power  of  the  Legis- 
lature to  reduce  the  freight  on  a  particular  article,  provided  the 
carriers  were  enabled  to  earn  a  fair  profit  upon  their  entire  inter- 
state traffic. 

The  case  was  appealed  to  the  U.  S.  Supreme  Court,  where  it 
was  affirmed  on  March  14,  1910,  216  V.  S.  579,  without  prejudice 
to  the  right  of  the  Company  to  reopen  the  case,  if  after  adequate 
trial  of  the  rate  in  question  the  Company  could  prove  that  it  was 
actually  confiscatory  and  amounted  to  a  deprivation  of  property 
without  due  process  of  law. 

In  his  opinion  Mr.  Justice  Holmes  said:  *'The  carriage  of 
coal  is  a  very  small  part  of  the  railroad's  business.  The  estimate  of 
the  cost  is  admitted  to  be  uncertain,  and  to  depend  in  part  upon 
arbitrary  postulates.  *  *  *  ^y^  j^  ^^^^  ^^y  |-j^^^  experiment 
may  not  establish  a  case  in  the  future  that  would  require  a  decision 
upon  the  question  of  constitutional  law,  but  we  can  express  no 
opinion  upon  it  now." 

The  decision  of  neither  Court  in  this  case  therefore  is  an 
authority  against  the  proposition  that  a  rate  is  invalid  which  does 
materially  affect  total  earnings,  which  affects  a  large  class  of  a  com- 
pany's customers,  and  which  can  be  shown  to  be  unreasonable  as 
to  such  class,  notwithstanding  the  fact  that  the  company  may  be 
able  to  earn  a  reasonable  profit  from  its  entire  schedule  of  rates  as 
applicable  to  all  of  its  customers.  These  decisions  are  applicable 
only  when  the  rate  in  question  affects  but  a  comparatively  small  pro- 
portion of  the  general  business  done,  and  its  effect  on  profits  is 
speculative. 

On  this  subject  see  also  notes  in  33  L.  R.  A.  183,  15  L.  R.  A. 
(N.  S.)  108,  and  25  L.  R.  A.  (N.  S.)  1001. 


Court  Review 

The  following  recent  case  is  illustrative  of  the  attitude  of  the 
Court  towards  an  order  made  by  a  Commission,  which  it  has  been 
asked  to  review: 

Minneapolis^  St.  Paul  and  Sault  Ste.  Marie  Railway  Company 
vs.  Railroad  Commission  of  Wisconsin,  136  Wisconsin  146 
(1908). 

Here  the  Supreme  Court  of  Wisconsin  was  asked  to  review  and 
reverse  on  its  merits  the  judgment  of  the  Circuit  Court,  refusing 
to  vacate  an  order  of  the  Railroad  Commission  as  unreasonable. 
The  order  required  certain  train  stops  to  be  made.  The  action  had 
been  brought  by  the  railway  company  under  the  provisions  of  the 
statute,  authorizing  a  court  review  of  the  orders  of  the  commis- 
sion, and  conferring  power  on  the  courts  to  vacate  such  orders, 
upon  the  ground  that  the  rate  fixed  was  unlawful,  or  the  regula- 
tion prescribed  was  unreasonable. 

The  statute  placed  the  burden  of  proof  upon  the  plaintiflF  in 
such  actions  "to  show  by  clear  and  satisfactory  evidence  that  the 
order  of  the  commission  complained  of  is  unlawful  or  unreasonable 
as  the  case  may  be." 

The  Court  was  called  upon  to  consider  the  general  principles  of 
rate  making  by  a  body  subordinate  to  the  legislature.  It  held  that 
its  functions  were  not  to  determine  whether  the  rate  or  service  fixed 
by  the  commission's  order  was  just  and  reasonable,  but  whether  the 
order  itself  was  unreasonable  or  unlawful ;  and  if  the  order  was  found 
to  be  such,  that  reasonable  men  might  well  differ  as  to  its  correct- 
ness, it  could  not  be  said  to  be  unreasonable.  It  held  further  that 
in  such  review  it  was  not  required  to  exercise  legislative  power  or 
to  make  rates;  that  its  duties  were  merely  to  determine  whether  the 
order  appealed  from  was  unreasonable,  and  if  so  found,  to  set  it 
aside,  and  leave  the  commission  to  take  further  action;  that  great 
weight  should  be  given  to  the  commission's  order,  and  a  very  strong 
case  must  be  made  to  establish  its  unreasonableness;  but  that,  how- 
ever, an  order  of  the  commission  need  not  be  confiscatory  in  its 
character  and  effect  in  order  to  be  unlawful  and  unreasonable  within 
the  meaning  of  the  statute.  ' 


REASONABLE  PROFIT  177 

Ex.   Rel.    Northern   Pacific   Railway   Company  vs.   Railroad 
Commission  of  Wisconsin y  140  Wisconsin,  145. 

Here  the  Court  again  ruled  that  unless  the  order  of  the  com- 
mission was  unlawful  or  unreasonable,  it  could  not  be  disturbed. 
The  case  involved  an  order  authorizing  a  grade  crossing  between 

two  roads. 

***** 

The  Michigan  Railroad  Commission  Act  of  1909  follows  closely 
the  Wisconsin  Act.  But  while  the  Wisconsin  Act  (Sec.  1797-m) 
authorizes  an  action  "to  vacate  and  set  aside  the  order  on  the  ground 
that  the  rate  fixed  is  unlawful,  or  that  the  regulations  fixed  are  un- 
reasonable, the  Michigan  Act  (No.  300,  Public  Acts,  1909,  Sec. 
92)  gives  the  court  jurisdiction,  not  merely  "to  affirm,  vacate,  or 
set  aside  the  order  of  the  commission  in  whole  or  in  part,"  but 
also  "to  make  such  other  order  or  decree"  as  it  "shall  decide  to  be 
in  accordance  with  the  facts  and  the  law."  The  validity  of  this 
Michigan  Act  has  not  been  passed  upon,  and  it  cannot  be  known 
whether  the  courts  wiir  undertake  themselves  to  fix  rates. 

Both  the  Michigan  and  Wisconsin  Acts  place  the  burden  of 
proof  upon  the  complainant  to  show  by  clear  and  satisfactory  evi- 
dence that  the  order  of  the  commission  complained  of  is  unlawful 
or  unreasonable,  as  the  case  may  be.  (Michigan  Act,  Sec.  96;  Wis- 
consin Act,  Sec.  70.) 

The  New  York  Act  which  creates  the  Public  Service  Commis- 
sions of  that  state  does  not  provide  for  a  court  review  of  their 
orders. 


Decisions  by  Railroad  Commission  of 
Wisconsin 

In  re  Menominee  and  Marinette  Light  and  Traction  Company 
{August  3,  1909),  3  Wise.  R.  Com.  Rep.  778. 

(Quoted  from  below.) 

Hill  vs.  Antigo  Water  Company  (August  3,  1909),  3  Wise. 
R.  Com.  Rep.  623. 

(Quoted  from  below.) 

State  Journal  Printing  Company  vs.  Madison  Gas  and  Elec- 
tric Company  (March  8,   1910),  4  Wis.  R.  Com.  Rep. — . 

(Quoted  from  below.) 

City  of  Ripon  vs.  Ripon  Light  and  Water  Company  (March 
28,  1910),  5  Wise.  R.  Com.  Rep.  —. 

Here  the  net  return  to  the  company  was  less  than  6%  in  nine 
out  of  14  years  investigated,  and  in  no  case  more  than  7%.  It  was 
held  that  the  earnings  were  not  unreasonable,  and  that  a  horizontal 
reduction  in  rates  could  not  be  made. 

In  re  Application  of  H.  T.  Windsor  Company  for  authority 
to  increase  rates  for  electric  current  (April  18,  1910),  5 
Wise.  R.  Com.  Rep.  — . 

Here  the  reasonable  profit  was  figured  at  8%. 

See  also  cases  of 

Chippewa  Falls  Water  Works  (June,  1910),  —  Wise.  R. 
Com.  Rep.  — . 

Manitowoc  Electric  Light  Company  (June  21,  1910),  — 
Wise.  R.  Com.  Rep.  — . 


Wilcox  vs.  Consolidated  Gas  Company 

212  U.  S.  19 
Extract  from  Opinion  of  the  Court  by  Mr.  Justice  Peckham 

*'In  order  to  determine  the  rate  of  return  upon  the  reasonable 
value  of  the  property  at  the  time  it  is  being  used  for  the  public,  it 
of  course  becomes  necessary  to  ascertain  what  that  value  is.    *    *    * 

"The  value  of  real  estate  and  plant  is  to  a  considerable  extent 
matter  of  opinion,  and  the  same  may  be  said  of  personal  estate  when 
not  based  upon  the  actual  cost  of  material  and  construction.  Deter- 
ioration of  the  value  of  the  plant,  mains  and  pipes  is  also  to  some 
extent  based  upon  opinion.  All  these  matters  make  questions  of 
value  somewhat  uncertain;  while  added  to  this  is  an  alleged  prospec- 
tive loss  of  income  from  a  reduced  rate,  a  matter  also  of  much  un- 
certainty depending  upon  the  extent  of  the  reduction  and  the 
probable  increased  consumption,  and  we  have  a  problem  as  to  the 
character  of  a  rate  which  is  difficult  to  answer  without  a  practical 
test  from  actual  operation  of  the  rate.  Of  course,  there  may  be  cases 
where  the  rate  is  so  low  upon  any  reasonable  basis  of  valuation,  that 
there  can  be  no  doubt  as  to  its  confiscatory  nature,  and  in  that  event 
there  should  be  no  hesitation  in  so  deciding  and  in  enjoining  its  en- 
forcement without  waiting  for  the  damage,  which  must  inevitably 
accompany  the  operation  of  the  business  under  the  objectionable 
rate.  But  where  the  rate  complained  of  shows  in  any  event  a  very 
narrow  line  of  division  between  possible  confiscation  and  proper 
regulation,  as  based  upon  the  value  of  the  property  found  by  the 
court  below,  and  the  division  depends  upon  opinions  as  to  value, 
which  differ  considerably  among  the  witnesses,  and  also  upon  the 
results  in  the  future  of  operating  under  the  rate  objected  to,  so  that 
the  material  fact  of  value  is  left  in  much  doubt,  a  court  of  equity 
ought  not  to  interfere  by  injunction  before  a  fair  trial  has  been  made 
of  continuing  the  business  under  that  rate  and  thus  eliminating 
as  far  as  is  possible  the  doubt  arising  from  opinions  as  opposed 
to  facts."     *     *     * 

"There  is  no  particular  rate  of  compensation  which  must  in  all 
cases  and  in  all  parts  of  the  country  be  regarded  as  sufficient  for 
capital  invested  in  business  enterprises.     Such  compensation  must 


180  DEVELOPMENT  OF  SCIENTIFIC  RATES 

depend  greatly  upon  circumstances  and  locality;  among  other  things, 
the  amount  of  risk  in  the  business  is  a  most  important  factor,  as  well 
as  the  locality  where  the  business  is  conducted  and  the  rate  expected 
and  usually  realized  there  upon  investments  of  a  somewhat  similar 
nature  with  regard  to  the  risk  attending  them.  There  may  be  other 
matters  which  in  some  cases  might  also  be  properly  taken  into  ac- 
count in  determining  the  rate  which  an  investor  might  properly 
expect  or  hope  to  receive  and  which  he  would  be  entitled  to  without 
legislative  interference.  The  less  risk,  the  less  right  to  any  unusual 
returns  upon  the  investments.  One  who  invests  his  money  in  a  busi- 
ness of  a  somewhat  hazardous  character  is  very  properly  held  to 
have  the  right  to  a  larger  return  without  legislative  interference  than 
can  be  obtained  from  an  investment  in  Government  bonds  or  other 
perfectly  safe  security.  The  man  that  invested  in  gas  stock  in  1823 
had  a  right  to  look  for  and  obtain,  if  possible,  a  much  greater  rate 
upon  his  investment  than  he  who  invested  in  such  property  in  the 
city  of  New  York  years  after  the  risk  and  danger  involved  had  been 
almost  entirely  eliminated. 

"In  an  investment  in  a  gas  company,  such  as  complainant's,  the 
risk  is  reduced  almost  to  a  minimum.  It  is  a  corporation  which  in 
fact,  as  the  court  below  remarks,  monopolizes  the  gas  service  of  the 
largest  city  in  America,  and  is  secure  against  competition  under  the 
circumstances  in  which  it  is  placed  because  it  is  a  proposition  almost 
unthinkable  that  the  city  of  New  York  would  for  purposes  of  making 
competition,  permit  the  streets  of  the  city  to  be  again  torn  up  in 
order  to  allow  the  mains  of  another  company  to  be  laid  all  through 
them  to  supply  gas  which  the  present  company  can  adequately  sup- 
ply. And,  so  far  as  it  is  given  us  to  look  into  the  future,  it  seems  as 
certain  as  anything  of  such  a  nature  can  be,  that  the  demand  for  gas 
will  increase,  and  at  the  reduced  price,  increase  to  a  considerable 
extent.  An  interest  in  such  a  business  is  as  near  a  safe  and  secure 
investment  as  can  be  imagined  with  regard  to  any  private  manufac- 
turing business,  although  it  is  recognized  at  the  same  time  that  there 
is  a  possible  element  of  risk,  even  in  such  a  business.  The  court 
below  regarded  it  as  the  most  favorably  situated  gas  business  in 
America,  and  added  that  all  gas  business  is  inherently  subject  to 
many  of  the  vicissitudes  of  manufacturing.  Under  the  circum- 
stances, the  court  held  that  a  rate  which  would  permit  a  return  of 
six  per  cent  would  be  enough  to  avoid  the  charge  of  confiscation, 
and  for  the  reason  that  a  return  of  such  an  amount  was  the  return 


REASONABLE  PROFIT  181 

ordinarily  sought  and  obtained  on  investments  of  that  degree  of 
safety  in  the  city  of  New  York. 

"Taking  all  facts  into  consideration,  we  concur  with  the  court 
below  on  this  question,  and  think  complainant  is  entitled  to  six  per 
cent  on  the  fair  value  of  its  property  devoted  to  the  public  use.  *  *  * 

"In  this  case  a  slight  reduction  in  the  estimated  value  of  the 
real  estate,  plants  and  mains,  as  given  by  the  witnesses  for  complain- 
ant, would  give  a  six  per  cent  return  upon  the  total  value  of  the 
property  as  above  stated.  And  again  increased  consumption  at  the 
lower  rate  might  result  in  increased  earnings,  as  the  cost  of  furnish- 
ing the  gas  would  not  increase  in  proportion  to  the  increased  amount 
of  gas  furnished. 

"The  elevated  railroads  in  New  York  when  first  built  charged 
ten  cents  for  each  passenger,  but  when  the  rate  was  reduced  to  five 
cents  it  is  common  knowledge  that  their  receipts  were  not  cut  in  two 
but  that  from  increased  patronage  the  earnings  increased  from  year 
to  year  and  soon  surpassed  the  highest  sum  ever  received  upon  the 
ten-cent  rate. 

"Of  course  there  is  always  a  point  below  which  a  rate  could  not 
be  reduced  and  at  the  same  time  permit  the  proper  return  on  the 
value  of  the  property,  but  it  is  equally  true  that  a  reduction  in  rates 
will  not  always  reduce  the  net  earnings  but  on  the  contrary  may 
increase  them.  The  question  of  how  much  an  increased  consumption 
under  a  less  rate  will  increase  the  earnings  of  complainant,  if  at  all, 
at  a  cost  not  proportioned  to  the  former  cost,  can  be  answered  only 
by  a  practical  test.  In  such  a  case  as  this,  where  the  other  data 
upon  which  the  computation  of  the  rate  of  return  must  be  based  are 
from  the  evidence  so  uncertain,  and  where  the  margin  between 
possible  confiscation  and  valid  regulation  is  so  narrow  we  cannot  say 
there  is  no  fair  or  just  doubt  about  the  truth  of  the  allegation  that 
the  rates  are  insufficient.     *     *     * 

"Upon  a  careful  consideration  of  the  case  before  us  we  are  of 
opinion  that  the  complainant  has  failed  to  sustain  the  burden  cast 
upon  it  of  showing  beyond  any  just  or  fair  doubt  that  the  acts  of  the 
legislature  of  the  State  of  New  York  are  in  fact  confiscatory. 

"It  may  possibly  be,  however,  that  a  practical  experience  of  the 
effect  of  the  facts  by  actual  operation  under  them  might  prevent  the 
complainant  from  obtaining  a  fair  return  as  already  described  and  in 
that  event  complainant  ouglit  to  have  the  opportunity  of  again  pre- 
senting its  case  to  the  court.  To  that  end  we  reverse  the  decree, 
with  directions  to  dismiss  the  bill  without  prejudice/' 


In  Re  Menominee  &  Marinette  Light  & 
Traction  Co. 

3  Wis.  R.  R.  Com.  Reps.,  778 

Extract  from  Opinion  of  Railroad  Commission  of  Wisconsin 

(August  3,  1909) 

Interest  and  Profits 

"When  the  plants,  are  new  and  conditions  more  uncertain,  the 
risks  are  greater  and  the  rates  of  profit  at  which  capital  will  enter 
the  field  are  usually  higher.  The  amount  which  constitutes  a  reason- 
able return  upon  the  investment  may  also  vary  with  both  local  and 
general  conditions.  In  a  general  way  the  reasonable  return  may  be 
said  to  be  that  rate  of  return  at  which  capital  and  business  ability 
can  be  had  for  development.  Theoretically  it  cannot  be  lower  than 
this,  for  in  that  case  no  capital  would  enter  the  field.  Under  free 
competition  it  could  not,  in  the  long  run,  be  higher  than  this  figure, 
for  if  it  was,  the  supply  of  capital  for  these  purposes  would  be 
increased  and  this  increase  in  turn  would  tend  to  reduce  the  rate  of 
profits  and  interest.  But  free  competition  is  out  of  the  question  in 
the  case  of  such  utilities,  for  they  are  monopolistic  in  their  nature. 
It  is  for  this  reason  that  in  the  case  of  such  monopolies  the  term 
"reasonable"  has  been  substituted  for  the  conditions  otherwise 
brought  about  through  competition.  Since  competition  did  not 
exist,  it  could  not  regulate,  hence  some  other  regulating  force  had 
to  be  resorted  to.  This  force  is  implied  in  regulation  through  abso- 
lute legislation,  and  this  regulation  is  guided  by  what  is  reasonable 
under  the  circumstances.  To  determine  what  is  reasonable  in  any 
given  case  is  a  matter  of  investigation  and  judgment.  Applied  to 
the  rate  of  interest,  the  reasonable  rate  is  the  rate  that  under  the 
conditions  is  fair  to  both  investors  and  consumers.  The  minimum 
rate,  in  such  cases,  should  be  limited  to  the  rate  at  which  capital 
could  be  had,  but  this  rule  is  perhaps  more  applicable  to  new  invest- 
ments than  to  investments  already  made,  although  it  is  not  without 
influence,  even  in  the  latter  case.  The,  reasonable  rate  of  interest 
and  profit  can,  perhaps,  be  said  to  be  a  rate  that  closely  approximates 
the  returns  that  are  received  upon  capital  invested  in  other  under- 
takings where  the  risks  involved  and  other  conditions  are  similar. 


REASONABLE  PROFIT  183 

Measured  by  this  standard,  these  rates  would  be  higher  when  the 
plants  are  new,  or  when  the  risks  are  greater,  than  later  on  when 
their  business  has  become  more  firmly  established.  It  would  also  be 
greater  than  the  rates  obtained  on  money  invested  in  mortgages  or 
in  other  places  where  the  risks  are  comparatively  low." 

***** 

*'As  bonds  to  the  extent  of  one-half  of  the  value  of  this  plant 
would  be  a  safe  investment  security,  five  per  cent  would  probably  be 
a  fair  rate  of  interest  thereon.  For  the  stock,  however,  which  cov- 
ered the  remaining  half  of  the  value  of  the  plant,  the  risks  would  be 
greater  but  owing  to  the  fact  that  the  business  is  in  the  nature  of 
a  monopoly,  the  risks  even  on  the  latter  half  would  be  less  than  in 
ordinary  commercial  and  industrial  undertakings  without  such 
monopoly  privileges.  As  the  rate  of  interest  or  profits  is  largely 
dependent  upon  risks,  it  would  seem  to  follow  that  the  rate  of 
interest  should  be  lower  in  the  former  than  in  the  latter  classes  of 
enterprises.  This  position  is  also  strengthened  when,  as  for  public 
utilities,  reasonable  returns  are  recognized  by  law." 


Extract  from  Opinion  of  Railroad  Commission 
of  Wisconsin 

(August  3,  1909) 

George  W.  Hill  et  al.  vs.  Antigo  Water  Co. 

Interest  and  Profits 

^'Having  thus  determined  the  fair  cost-value  of  the  plant  itself 
as  well  as  of  its  business,  and  explained  the  operating  expenses,  the 
next  step  will  consist  in  ascertaining  what  is  a  reasonable  rate  of 
interest  and  profit  upon  the  amount  so  invested.  These  rates  of 
return  are  important  factors.  On  the  one  hand,  they  must  be  high 
enough  to  secure  the  necessary  capital  and  business  ability;  on  the 
other  hand,  they  should  not  be  as  high  as  to  be  unreasonable  to  the 
consumers.  The  problem,  therefore,  is  to  find  rates  that,  under  the 
circumstances,  are  reasonable  to  both.  Generally  speaking,  it  can  be 
said  that  they  depend  upon  the  cost  of  obtaining  the  capital  and  the 
business  skill  that  are  required.  It  can  also  be  stated  that,  like  the 
cost-value  of  the  plant  and  its  business,  these  rates  must  be  deter- 
mined by  investigation.  The  conditions  in  this  case,  insofar  as 
interest  is  concerned,  are  not,  on  the  whole,  as  satisfactory  as  they 
might  be,  and  some  space  will,  therefore,  have  to  be  devoted  to 
their  analysis. 

"The  term  'interest'  is  well  understood  and  needs  little  or  no 
explanation.  It  is  the  amount  paid  for  the  use  of  capital.  For  the 
term  'profit'  the  situation  is  somewhat  different,  since  it  is  used  in 
various  ways.  The  courts  hold,  in  substance,  that  the  investor  is 
entitled  to  a  reasonable  return  or  reward  for  his  enterprise,  his  risk 
and  the  devotion  of  his  capital  to  the  service  of  the  public.  The 
return  or  profit  under  this  definition  appears  to  include  interest,  or 
the  share  of  the  investor,  as  well  as  profits,  or  the  share  of  the 
entrepreneur.  Those  who  carry  on  the  business  may  be  investors  as 
well  as  the  organizers  and  directors  of  the  factors  of  production, 
but  this  does  not  necessarily  imply  that  interest  and  profits  should 
not  be  kept  separate.  The  older  economists  generally  classed  inter- 
est with  profits.  Later  writers  upon  this  subject,  however,  in  the 
light  of  further  and  more  complete  analysis  of  the  facts  involved, 
have  separated  these  two  factors  and  have  classed  them  according 


REASONABLE  PROFIT  185 

to  their  nature.  As  interest  arises  from  the  use  of  capital,  and  profits 
have  their  source  in  the  business  ability,  skill  and  foresight  of  the 
management,  as  well  as  in  the  risks  assumed  by  it  or  by  the  entre- 
preneur, it  would  hardly  seem  logical  to  put  both  of  these  factors  in 
the  same  class. 

"The  facts  with  respect  to  interest  on  the  capital  used  are  per- 
haps better  understood  than  those  connected  with  the  profits.  In- 
terest is  justifiable  and  necessary,  because  of  the  importance  of 
capital  in  production,  and  because  capital  cannot  be  had  for  such 
purposes  unless  something  is  paid  for  its  use.  Capital  in  and  of 
itself,  or  when  standing  alone,  may  not,  in  the  full  sense  of  the  term, 
be  a  productive  agent,  but  when  used  in  connection  with  other 
factors,  under  the  direction  of  a  competent  employer,  it  is  one  of  the 
principal  factors  of  production.  When  capital  is  applied  in  produc- 
tion under  these  conditions,  it  becomes  the  means  through  which  a 
larger  product  is  obtained  at  the  same  or  at  less  cost  than  when  not 
so  applied.  This,  in  turn,  results  in  a  greatly  reduced  cost  per  each 
unit  of  product.  Without  the  assistance  of  capital  the  whole  pro- 
ductive process,  as  it  is  known  today,  would  simply  be  out  of  the 
question.  Where  the  factors  of  production  are  properly  co-ordinated, 
capital  is  as  important  and  as  essential  as  any  of  the  other  factors 
and  is,  therefore,  entitled  to  its  share  of  the  joint  product.  In  fact, 
this  share  must  be  paid  or  capital  will  not  be  forthcoming.  Capital 
is  obtained  only  through  savings,  and  savings  mean  costs  or  sacrifices 
of  many  kinds.  It  represents  cost;  and  people  will,  therefore,  not 
save  and  permit  their  savings  to  be  used  in  productive  enterprises 
unless  they  get  some  return  upon  their  sacrifices  and  for  the  risks 
they  necessarily  have  to  assume.  But  since  under  the  conditions 
named,  capital  is  productive,  employers  are  willing  and  glad  to  pay 
some  such  compensation  in  the  form  of  interest.  Interest  so  paid 
becomes  as  much  a  cost  of  production  as  the  wages  that  must  be 
paid  for  the  labor  that  enters  into  the  products.  These  facts  not 
only  justify  interest,  but  enable  entrepreneurs  to  pay  it. 

"The  cost  to  the  entrepreneur  of  the  capital  employed  is  thus 
measured  by  the  interest  that  must  be  paid  for  its  use.  The  rate 
of  interest,  in  turn,  depends  on  the  demand  for  and  the  supply  of 
capital.  When  the  demand  is  greater  than  the  supply,  the  rate  is 
comparatively  high,  and  vice  versa.  The  rate  of  interest  actually 
paid  for  the  use  of  capital,  however,  is  greatly  affected  by  such 
elements  as  the  amount  of  management  required  in  placing  and 


186  DEVELOPMENT  OF  SCIENTIFIC  RATES 

looking  after  the  loans,  and  the  risks  involved  which  affect  their 
security.  Money  placed  in  trust  companies  and  savings  banks  yields 
about  4  per  cent.  Such  placing  of  money  involves  perhaps  the 
minimum  amount  of  supervision,  management  and  risk  of  any  of  the 
investments  that  are  open  to  the  general  public,  and  the  interest 
received  thereon  may,  therefore,  be  regarded  as  net  interest.  Money 
invested  in  real  estate  mortgages,  where  the  mortgage  does  not  ex- 
ceed 50  per  cent  of  the  normal  market  value,  appears  to  yield  about  5 
per  cent.  In  this  case  the  security  is  usually  ample,  but  a  certain 
amount  of  management  is  required  in  placing  and  loftking  after  the 
loans.  This  involves  some  sacrifice  or  cost,  and  this  is  included  in 
the  interest.  In  addition  to  this,  such  mortgages  are  not  always  as 
easily  discounted  as  might  be  desirable,  especially  to  those  who,  for 
one  reason  or  another,  may  find  it  to  their  advantage  to  hold  securi- 
ties that  are  readily  converted  into  cash.  Mortgages  covering  a 
greater  proportion  of  the  market  value  of  the  property  often  bear 
6,  7,  and  even  higher  rates  of  interest,  and  even  at  this  may  not  find 
a  ready  market  at  par.  What  is  true  of  mortgages  is  also  true  of 
securities  generally.  First-class  railroad  bonds  may  sell  on  a  4  or  5 
per  cent  basis,  while  lower  grade  bonds,  stocks,  and  commercial 
paper  are  usually  selling  at  prices  that  yield  much  higher  returns. 
From  this  it  appears  that  while  the  net  interest  rate  is  about  4  per 
cent,  the  gross  rate  is  much  higher,  varying  with  the  work  of  man- 
agement and  with  the  security  or  safety  of  the  investment.  For  a 
mortgage,  for  instance,  which  bears  interest  at  5  per  cent  and  sells 
at  par,  the  net  rate  is  probably  about  4  per  cent,  while  one-half  of 
one  per  cent  in  each  case  may  cover  management  and  risks. 

"The  securities  of  public  service  corporations  sell  at  almost  all 
kinds  of  prices.  Bonds  which  do  not  exceed  one-half  of  the  cost- 
value  of  the  plant  and  its  business  sometimes  sell  on  a  5  per  cent 
basis,  and  at  other  times  again  at  prices  that  yield  higher  returns. 
When  the  bonds  cover  a  greater  proportion  of  the  value  than  this, 
the  price  is  lower,  often  so  low,  in  fact,  that  the  yield  is  from  6  to  7 
per  cent  and  even  more.  The  prices  of  such  securities  are  greatly 
affected  by  local  conditions,  such  as  the  volume  of  the  business  of 
the  plants,  the  character  of  their  management,  the  relations  which 
obtain  between  these  utilities  and  the  communities  which  they  serve, 
the  manner  in  which  their  finances  have  been  handled,  and  on  other 
facts  of  this  nature. 

"Securities  of  public  utilities  that  are  not  overcapitalized  ought 
to  be  among  the  safest  of  investments.     Such  utilities  are  monopo- 


REASONABLE  PROFIT  187 

listic  in  their  nature  and  therefore  not  often  exposed  to  all  the 
hazards  of  competition.  The  services  they  render  are,  in  most 
instances,  necessities.  They  are  of  such  nature  that  people  cannot 
often  get  along  without  them.  Conditions  are  also  usually  such  that 
these  services  can  be  furnished  at  rates  that  are  low  enough  to  insure 
takers,  and  at  the  same  time  high  enough  to  cover  operating  ex- 
penses, including  fair  returns  on  the  investment.  Industries  so  situ- 
ated are  usually  regarded  with  a  great  deal  of  favor  by  conservative 
investors.  Their  5  per  cent  bonds  ought  to  sell  at  par.  This  is  cer- 
tainly the  case  when  the  bonds  amount  to  less  than  the  cost-value  of 
the  plant,  or  for  public  utilities  which  have  passed  the  development 
period  and  the  earnings  of  which  are  ample  to  cover  all  legitimate 
demands  that  are  made  upon  them.  But  such  securities  do  not  often 
sell  at  such  prices.  For  this  local  conditions  are  often  responsible. 
For  instance,  the  relations  between  the  plant  and  the  community  it 
serves  may  be  strained  or  irritating.  This  relation  may  be  as  em- 
barrassing or  harmful  when  caused  by  political  agitation  and  strife 
as  when  due  to  lack  of  tact  or  to  arbitrary  methods  on  the  part  of 
the  management  of  the  plant. 

"When,  as  is  often  the  case,  the  management  of  such  plants  is  of 
the  more  speculative  kind  and  expends  greater  eflForts  in  selling  se- 
curities than  in  rendering  adequate  services  at  reasonable  rates,  the 
situation  becomes  even  more  aggravated.  In  such  cases  the  real 
value  of  the  securities,  especially  the  stock,  is  very  uncertain.  It  can, 
as  a  rule,  be  ascertained  only  by  the  most  thorough  inquiry  into  the 
conditions  of  the  plant,  the  methods  of  doing  business,  and  the  rec- 
ords of  the  company  generally.  The  comparatively  poor  standing  in 
the  market  of  a  large  proportion  of  the  securities  of  public  service 
corporations  is  as  much  due  to  reckless  or  unscrupulous  financial 
methods  on  the  part  of  their  managements  as  to  any  other  cause. 
For  full  confirmation  of  this  we  do  not  have  far  to  seek.  It  is  ap- 
parent almost  everywhere  that  securities  are  handled.  It  has  aided 
very  materially  in  creating  a  situation  under  which  local  and  small 
investors  avoid  such  securities  when  they  invest  their  savings  and  in 
largely  closing  the  local  markets  for  such  securities,  which  is  a  dis- 
advantage all  around,  for  the  local  market  ought  to  be  the  most 
natural  as  well  as  the  most  advantageous  market  for  them.  The 
benefits  that  might  accrue  from  having  the  securities  placed  among 
the  people  which  the  plants  are  serving  cannot  easily  be  overesti- 
mated. But  such  local  markets,  particularly  among  the  small  in- 
vestors, are  not  likely  to  be  more  generally  developed  until  it  has 


188  DEVELOPMENT  OF  SCIENTIFIC  RATES 

been  fully  demonstrated  that  the  plants  are  safely  and  conserva- 
tively managed. 

"x\s  the  bonds  constitute  a  lien  upon  the  property,  this  part  of 
the  investment  is,  as  a  rule,  much  better  secured  than  the  stock, 
which  has  no  claim  upon  the  assets  until  all  the  liabilities  have  been 
met.  In  fact,  the  stockholders  may,  within  certain  limits,  be  held 
responsible  for  the  liabilities  of  the  plant,  and  the  stock  may,  there- 
fore, become  an  obligation  rather  than  a  clam.  Bonds  are  not  only 
better  secured  than  the  stock,  but  they  carry  no  such  obligations. 
The  risks  attendant  upon  investments  in  bonds  are,  therefore,  much 
smaller  than  in  stocks.  Since  the  risks  are  less  in  the  former  case,  it 
also  follows  that  the  rate  of  interest  thereon  is  lower.  In  the  com- 
mercial world  for  instance,  twice  as  high  a  rate  of  return  is  often 
required  for  stocks  as  for  bonds  in  order  that  they  may  sell  at  the 
same  price.  The  bondholder  gets  interest  at  a  stipulated  rate,  no 
more  and  no  less,  but  his  claims  precede  those  of  the  stockholder. 
The  stockholder,  on  the  other  hand,  receives  the  surplus  in  the  busi- 
ness above  the  operating  expenses,  including  interest  on  the  bonds, 
whatever  it  may  amount  to.  If  this  surplus  is  great,  the  rate  of 
return  on  the  stock  may  be  high.  If  the  surplus  is  small,  then  the 
returns  on  the  stock  will  also  be  small.  These  are  some  of  the  more 
important  differences  as  between  the  position  of  bondholders  and 
stockholders.  The  difference  in  the  rate  or  price  in  the  two  cases  is 
almost  entirely  due  to  the  difference  in  the  risks  to  which  the  invest- 
ments are  exposed.  The  risks  are  also  greater  when  the  plants  are 
new  than  later  on  when  their  business  becomes  established.  That 
this  should  be  the  case,  is  perhaps  natural.  In  the  first  place,  there 
is  always  some  doubt  as  to  the  success  of  new  undertakings.  Unfore- 
seen obstacles  may  arise  in  the  construction  which  tend  to  materially 
increase  its  cost.  Mistakes  of  various  kinds  may  also  occur  which 
may  not  only  enhance  the  cost  but  result  in  a  defective  plant.  There 
may  also  be  doubts  as  to  how  long  a  plant  of  this  kind  will  have  to 
be  carried  before  the  earnings  become  large  enough  to  meet  the 
expenses.  In  fact,  few  water  works  pay  during  their  earlier  years, 
and  this  is  also  true  of  other  utilities.  Facts  like  these  always  tend 
to  retard  investments  and,  therefore,  also  have  the  effect  of  keeping 
interest  rates  at  a  higher  level  for  new  than  for  older  plants. 

"That  interest  rates  are  higher  at  first  than  later  on  is  shown 
by  the  financial  history  of  most  successful  public  utilities  and  of  other 
enterprises.     In  the  cases  of  most  railroads  the  bonds  which  were 


REASONABLE  PROFIT  189 

issued  for  the  first  part  of  the  construction  work  often  bear  twice 
as  high  interest  as  bonds  that  were  issued  since  the  traffic  had  been 
developed.  Many  of  the  earHer  issues,  for  instance,  bear  interest 
at  the  rate  of  7  per  cent,  and  even  at  this  had  to  be  sold  at  heavy 
discounts,  while  the  later  issues  bear  interest  at  3j^  and  4  per  cent 
and  sell  at  par.  Such  cases  are  common  rather  than  exceptional,  a 
fact  that  may  be  learned  by  a  simple  examination  of  the  bond  issues 
and  their  prices  for  the  various  roads  throughout  the  country.  What 
is  true  for  railroads  in  this  respect  is  also  true  for  the  various  other 
utilities.  The  rate  of  interest  is  almost  invariably  higher  for  the 
earlier  than  for  later  issues.  The  original  bonds,  bearing  6  per  cent 
interest  and  sold  at  as  low  prices  as  80  per  cent  of  the  par  value, 
are  often,  when  due,  replaced  by  5  per  cent  bonds  selling  at  par. 
These  are  apt  illustrations  of  the  effect  of  risks  upon  the  minds 
and  actions  of  investors.  Facts  like  these  demand  consideration,  not 
only  in  determining  the  fair  rate  of  interest  in  each  case,  but  in 
establishing  the  value  or  amount  upon  which  such  interest  should 

be  paid." 

***** 

"In  addition  to  the  operating  expenses,  including  depreciation 
and  the  amount  actually  paid  as  interest  on  the  investment,  there 
must  also  be  some  allowance  for  those  who  carry  on  the  business 
and  who  assume  all  the  risks  and  responsibilities  connected  there- 
with. This  allowance  is  usually  called  profit  and  represents  com- 
pensation for  the  work  of  managing  the  business,  for  the  risks  in- 
volved and  for  certain  other  efforts.  As  in  this  case  the  conditions 
which  affect  profits  are  about  normal,  it  will  not  be  necessary  to 
discuss  the  matter  at  any  great  length  at  this  time. 

"The  amount  of  work  required  of  the  management  depends  very 
largely  upon  the  nature  of  the  business,  the  relation  of  the  fixed  to 
the  variable  capital,  and  competitive  conditions.  Where  the  propor- 
tion of  current  to  fixed  capital  is  relatively  large  and  where  com- 
petition is  active,  the  duties  that  fall  upon  the  management  are 
usually  more  arduous  than  where  the  capital  largely  consists  of  a 
durable  and  easily  operated  plant,  where  its  products  or  services  are 
simple  and  where  they  are  practically  disposed  of  in  a  non-competi- 
tive market.  Water  works  come  in  the  latter  class.  In  the  case  of 
the  plant  involved  in  these  proceedings  the  cost  of  the  management, 
as  already  pointed  out,  amounts  to  about  $1,200  annually,  and  as 
this  cost  is  charged  directly  to  the  operating  expenses,  no  allowance 
should  be  made  for  it  under  profits. 


190  DEVELOPMENT  OF  SCIENTIFIC  RATES 

"The  risks,  also,  are  much  greater  in  some  industries  than  in 
others.  Where  the  products  depend  on  fashions,  the  season,  or  are 
of  a  perishable  character,  the  risks  are  relatively  great.  This  is  also 
true  where  competitive  conditions  are  unrestricted.  Where,  on  the 
other  hand,  the  products  or  services  are  necessities,  more  durable 
and  uniform,  and  where  competitive  conditions  are  restricted,  the 
risks  are  relatively  small.  Water  works  supply  a  service  that,  in 
most  cases,  is  indispensable.  They  usually  have  little  or  no  other 
competition  to  contend  against  than  such  water  supplies  as  may  be 
obtained  from  wells  and  nearby  rivers  and  lakes,  and  such  competi- 
tion is  not  often  serious.  But  while  for  water  works  the  risks  from 
the  sources  mentioned  are  small,  there  are  certain  other  risks  in  con- 
nection with  them  that  should  be  given  some  consideration  in  this 
connection.  For  instance,  in  both  their  construction  and  operation 
many  accidents  may  be  met  with  and  many  mistakes  may  occur. 
Water  works  are  also  injured  by  diversions  in  the  growth  of  the  city 
in  directions  different  from  those  which  were  expected  when  the 
plant  was  designed  and  constructed;  by  failure  of  the  city  to  grow 
as  rapidly  as  expected  or  as  the  plant  had  been  prepared  for;  by 
failure  on  the  part  of  the  city  to  grow  at  all,  or  by  actual  decrease 
in  its  population  and  industries;  by  certain  actions  of  local  and  other 
authorities  through  which  unprofitable  extensions  may  be  required, 
the  rates  reduced  and  other  burdens  imposed,  as  public  utilities 
usually  have  to  furnish  adequate  service  whether  they  are  paying  or 
not.  In  case  of  such  losses,  the  owners  are  the  first  to  suffer,  as 
their  share  oi  the  income  of  the  plant  is  not  fixed,  but  they  have  to 
take  what  is  left  after  all  other  claims  have  been  met.  Operating 
expenses,  taxes  and  interest  must  be  paid  if  the  plant  is  to  run.  If 
the  earnings  are  only  large  enough  to  meet  these  outlays,  the  owners, 
or  those  who  carry  on  the  business,  will  have  to  go  without  pay. 
From  this  there  is  no  escape.  In  view  of  these  and  other  facts  it  is 
clear  that  public  utilities  are  not  entirely  exempted  from  risks,  and 
that,  therefore,  there  is  a  speculative  feature  about  them  which  falls 
upon  those  who  carry  on  the  business  and  for  which  they  are  en- 
titled to  something  in  the  way  of  compensation." 


"As  water  works,  generally  speaking,  are  among  the  safest  of 
undertakings  when  once  they  have  reached  a  paying  basis,  safer,  in 
fact,  than  most  other  local  utilities,  the  speculative  gains  therein 
should  be  comparatively  low.  This,  however,  does  not  always  appear 


REASONABLE  PROFIT  191 

to  be  the  view  investors  take,  which  is  evidenced,  in  cases  like  the 
one  before  us  here,  by  the  low  prices  at  which  bonds  must  be  sold, 
or  the  high  rates  that  must  be  paid  for  capital  and  loans.  But  while 
the  plant  under  investigation  has  to  pay  rather  high  rates  of  interest, 
its  financial  condition  seems  to  us  fairly  sound,  and  there  is  every 
reason  to  believe  that  it  will  greatly  improve  in  the  near  future.  Its 
earnings  are  on  a  comparatively  sound  basis  and  its  securities  would 
seem  to  be  fairly  well  protected.  It  appears  to  us,  that  for  interest 
and  profits,  when  taken  together,  a  surplus  of  about  7  per  cent  on 
the  value  of  the  plant  and  its  business  as  here  given,  is  probably 
sufficient  to  secure  both  the  capital  and  the  business  capacity  re- 
quired, and  this  amount  we  therefore,  at  this  time,  regard  as  a 
reasonable  return  for  these  factors  in  this  particular  case. 

"Industries  generally,  including  corporations,  should  be  fairly 
treated.  States  or  communities  which  do  not  do  this,  will  soon  have 
occasion  to  realize  that  they  are  pursuing  a  wrong  policy.  A  state 
commission,  especially  when  dealing  with  rates  of  public  utilities, 
should  endeavor  to  reach  results  that  are  fair  and  equitable  and  in 
line  with  the  best  public  policy.  This  is  as  true  when  considered 
from  the  point  of  view  of  the  public,  as  when  looked  upon  from  the 
point  of  view  of  the  utilities. '  With  respect  to  the  latter  it  can  be 
said,  that  under  normal  conditions  their  rates  must  be  high  enough 
to  leave  an  adequate  surplus  for  those  who  assume  the  risks  and 
responsibilities  that  are  involved  and  to  encourage  new  capital  in 
entering  such  undertakings.  Such  rates,  when  warranted  by  con- 
ditions, are  not  only  just,  but  necessary.  Generally  speaking,  there 
is  more  risk  in  new  than  in  older  utilities,  and  hence  it  also  follows 
that  higher  profits  should  be  allowed  for  the  former.  This  is  in 
accordance  with  past  practices  and  sound  economic  principles.  As 
the  utilities  become  somewhat  older  in  the  places  they  serve  and 
attain  to  a  better  development  of  their  business,  the  risks  involved 
are  decreasing,  and  w4th  such  decreases  in  the  risks  it  is  only  fair 
that  there  should  be  decreases  in  their  profits.  Older  and  better 
established  utilities  can  also  secure  money  for  extensions  at  lower 
rates  than  new  utilities.  This  applies  also  in  renewing  their  bond 
issues  and  other  loans.  In  many  cases  they  are  even  able  to  refund 
outstanding  bond  issues  at  much  more  favorable  rates  of  interest 
than  the  rates  paid  in  the  past.  In  view  of  this  it  is  clear  that  there 
should  also  be  a  gradual  decline  in  the  rates  of  interest  of  such 
plants.  This  is  also  an  important  fact,  for  it  is  undoubtedly  the  case 
that  the  rate  of  interest  actually  paid  is  one  of  the  elements  that 


192  DEVELOPMENT  OF  SCIENTIFIC  RATES 

should  be  taken  into  account  in  considering  all  interest  allowances 
on  the  investment. 

"There  is  also  another  fact  that  argues  for  cautiousness  on  the 
part  of  commissions  in  fixing  rates  of  charge  for  public  utilities,  and 
that  is,  that  it  is  usually  the  most  profitable  from  a  social  point  to  not 
restrict  conditions  under  which  business  is  done  to  such  a  point  as  to 
discourage  undertakers  from  putting  their  best  efforts  into  their  en- 
terprises. Man  is  naturally  acquisitive.  If  you  give  him  a  chance  of 
sharing  in  the  benefits  therefrom,  he  is  almost  certain  to  work  hard 
to  turn  out  his  products  at  the  lowest  possible  cost.  He  will,  as  a 
rule,  practice  economy  wherever  possible.  For  instance,  he  will  con- 
struct his  plant  at  the  lowest  cost.  He  will  secure  and  keep  only 
efficient  assistants.  He  will  make  his  contracts  on  the  most  favor- 
able terms.  He  will  adopt  the  best  systems  of  management  and  op- 
eration. He  will  introduce  the  best  machinery  and  methods  of  pro- 
duction wherever  they  are  likely  to  result  in  savings.  In  short,  he 
will  display  diligence  and  close  supervision  in  every  department,  and 
in  these  and  various  other  ways  keep  the  cost  of  production  down  to 
the  lowest  possible  amount.  This  economy  of  efforts,  or  reduction 
in  cost,  is  peculiar  to  enterprises  carried  on  for  private  gain.  In 
fact,  it  is  nearly  always  present  in  successful  competitive  undertak- 
ings, and  where  there  is  something  in  a  pecuniary  way  to  be  gained 
thereby  But  such  efforts  are  not  likely  to  be  put  forth  where  no 
such  gains  are  in  sight.  Few  men  like  to  work  any  harder  than 
necessary  to  attain  a  given  end.  If  the  compensation  is  no  greater 
for  extraordinary  than  for  moderate  efforts,  the  former  are  not  likely 
to  be  very  common.  In  fact,  they  are  likely  to  be  the  exception 
rather  than  the  rule.  That  this  is  in  accord  with  the  facts,  is  often 
amply  demonstrated  by  the  manner  in  which  many  public  under- 
takings are  carried  on.  It  is  also,  as  said,  in  line  with  human 
nature  as  shown  in  almost  every  walk  of  life,  and  is  also  generally 
acknowledged  to  be  a  fact. 

"These  facts  are  extremely  important,  and  this  for  the  reason 
that,  generally  speaking,  there  is  only  one  way  in  which,  in  the 
absence  of  monopoly  features,  rates  or  prices  can  be  permanently 
reduced,  and  that  is  through  a  lowering  of  the  cost  of  production. 
Reductions  in  this  cost,  for  instance,  may  be  made  the  means 
through  which  not  only  lower  rates  for  the  consumers,  but  greater 
profits  for  the  producers  are  obtained.  That  this  is  the  case  is  con- 
stantly exemplified  in  every  day  life.     Since  such  reductions  in  the 


REASONABLE  PROFIT  193 

cost  are  not  likely  to  be  had  unless  the  employers  are  compensated 
therefor,  it  follows  that  if  the  rates  are  fixed  at  so  low  a  figure  as  to 
prevent  all  compensation  of  this  kind,  the  opportunities  for  rate 
reductions  will  also  be  decreased.  If  the  rates  of  public  utilities  are 
kept  at  so  low  a  point  as  to  offer  no  chances  of  any  kind  for  any 
returns  to  the  owners  above  those  which  are  absolutely  necessary  to 
keep  the  plant  running,  it  is  also  almost  certain  that  all  progress  in 
these  industries  will  be  greatly  retarded,  and  that  the  interests  of 
the  public  will  be  less  well  served  in  the  end  than  if  a  more  liberal 
policy  with  respect  to  rates  had  been  adopted. 

*'But  the  customers  of  public  utiHties  should  also  be  fairly 
treated.  The  customers  are  entitled  to  adequate  service  at  reason- 
able rates.  They  should  not  be  charged  monopoly  profits  nor  be 
burdened  with  the  bad  and  inequitable  results  of  discriminatory 
rates.  The  owners  of  such  utilities  assume  important  responsibili- 
ties towards  the  public,  and  these  should  be  met  to  the  best  of  their 
abilities.  Managers  of  these  utilities  who  adopt  a  policy  that  is  in- 
different, if  not  absolutely  arrogant,  disregarding  even  reasonable 
demands  on  the  part  of  their  customers,  are,  in  the  long  run,  almost 
certain  to  be  losers  from  this  course. 

"All  of  these  facts  are  of  the  greatest  importance  and  should  be 
given  the  fullest  possible  consideration  in  all  cases  where  questions 
as  to  rates  and  services  are  involved.  In  fact,  a  commission  in  fix- 
ing such  rates  and  passing  upon  the  services  rendered,  should  take 
all  facts  and  conditions  into  account.  It  should  be  as  much  guided 
by  the  ultimate  as  by  the  temporary  interests  of  both  the  utility  and 
its  customers. 

"If  the  preceding  analysis  of  interest  and  profits,  or  of  the  part 
which  capital  and  the  employer  play  in  modern  production  or  in  the 
services  rendered  by  public  utilities,  is  even  approximately  correct, 
then  it  also  follows  that  interest  proper  should  include  only  the 
amount  that  is  paid  for  the  use  of  the  capital  employed;  that  profits 
consist  of  the  wages  of  management,  broadly  interpreted,  of  com- 
pensation for  the  risks  and  responsibilities  that  must  be  borne  by 
the  employers,  and  of  such  other  compensation,  if  any,  as  may  be 
demanded  by  the  conditions;  that  each  of  these  elements,  in  the 
long  run,  must  be  high  enough  to  attract  capital  and  business  ability 
into  such  utility  enterprises;  and  that  it  is  the  duty  of  the  commis- 
sion, in  passing  upon  matters  in  which  interest  and  profits  are  in- 
volved, to  determine  in  each  particular  case  how  much  is  to  be 
allowed  for  each  of  these  elements." 


Extract  from  Opinion  of  Railroad  Commission 
of  Wisconsin 

(March  8,  1910) 

State  Journal  Printing  Co.  vs.  Madison  Gas  &  Electric  Company 

Interest  and  Profits 

"While  public  utilities  are  subject  to  many  conditions  that  tend 
to  increase  the  risks  under  which  their  business  is  carried  on,  they 
are  also  afforded  a  great  deal  of  protection  that  is  of  considerable 
value  to  the  investors.  This  protection  has  its  source  partly  in  legal 
provisions,  and  partly  in  the  fact  that,  after  all,  such  utilities  are 
natural  monopolies  and  are  engaged  in  furnishing  services  that  have 
practically  become  necessities  and  for  which  there  appear  to  be  no 
effective  substitutes.  While  the  investors  in  gas  and  electric  light 
plants  are  exposed  to  certain  hazards  or  risks,  these  risks,  while 
greater  than  the  risks  which  obtain  for  money  placed,  say,  in  trust 
companies  and  good  mortgages,  are  not,  on  the  whole,  as  great  as 
those  which  obtain  in  ordinary  competitive  enterprises.  This  is  as 
true  for  the  plants  involved  in  these  proceedings  as  for  such  plants 
generally. 

"The  rates  of  return  upon  the  investment  are  usually  divided 
into  interest  which  goes  to  those  who  furnish  the  capital,  and  profits 
which  go  to  those  who  assume  the  responsibility  and  direction  of  the 
business.  The  rate  of  interest  depends  on  the  supply  and  demand  for 
capital  and  is,  therefore,  lower  where  the  risks  are  low  and  where 
the  troubles  involved  in  looking  after  the  investments  are  small,  than 
where  these  elements  are  greater.  That  this  should  be  the  case,  is 
only  natural,  for  few  are  willing  to  assume  risks  and  responsibilities 
unless  they  are  compensated  therefor  in  some  form,  or  unless  the 
prospects  for  such  compensation  are  fairly  good.  There  are  other 
factors  than  those  given  which  also  affect  the  rate  of  interest,  such 
as  the  readiness  with  which  the  money  may  be  withdrawn,  the  loca- 
tion and  nature  of  the  industries,  etc.,  which  have  been  fully  de- 
scribed in  other  decisions,  but  these  are,  perhaps,  in  most  instances 
of  smaller  importance.  Money  placed  in  savings  banks,  trust  com- 
panies and  good  mortgages  yield  from  about  4  to  about  5  per  cent. 
In  the  case  of  such  investments  the  risks  are  very  small  and  they 


REASONABLE  PROFIT  195 

require  but  little  care  or  trouble.  These  rates  consist  mostly  of  pure 
interest  and  can,  perhaps,  be  regarded  as  the  minimum  rates  that 
are  obtained  by  the  ordinary  investors.  Money  invested  in  good 
bonds  for  which  there  is  a  ready  market  bring  no  more  than  the 
above  rates,  if  as  much.  Bonds  and  mortgages  of  a  somewhat 
lower  grade  yield  from  6  per  cent  up  to  8  per  cent  or  more,  and 
commercial  paper  brings  from  6  to  perhaps  10  per  cent  or  better.  In 
fact,  there  are  such  variations  in  both  the  character  of  the  invest- 
ments and  the  rates  they  yield,  that  it  is  difficult,  if  not  impossible, 
to  properly  classify  them. 

"The  bonds  of  the  company  involved  in  the  present  proceedings 
which,  as  already  pointed  out,  amount  to  about  $400,000,  covering 
less  than  one-half  of  the  value  of  the  plants,  bear  interest  at  the  rate 
of  6  per  cent  and  sell  at  from  $106  to  $108,  thus  yielding  about  5.6 
per  cent  on  their  price.  These  bonds  are  amply  secured,  being 
backed  by  the  entire  value  of  the  plant  as  well  as  by  its  earnings, 
which  show  a  surplus  above  the  operating  expenses  and  depreciation 
that  is  several  times  as  great  as  the  amount  required  to  meet  the 
interest  charges  on  these  bonds.  If  this  bond  issue  had  equaled  the 
cost  of  the  physical  property  of  these  plants,  the  chances  are  that 
they  would  sell  at  even  less  than  par,  and  this  regardless  of  the  fact 
that,  because  of  the  connections  of  the  owners  of  these  plants,  their 
securities  had  an  unusually  well  developed  market.  There  are  also 
certain  debentures  outstanding  against  these  plants  which  bear  in- 
terest at  7  per  cent.  As  these  debentures  do  not  appear  to  be  quoted 
in  any  of  the  regular  markets,  we  are  [un]able  to  give  their  market 
value;  while  they  bear  a  higher  rate  of  interest  than  the  bonds  and 
would  seem  to  be  about  as  well  secured,  they  do  not  constitute  the 
first  claim  upon  the  assets  of  the  company,  and  it  is  therefore  not 
likely  that  they  would  sell  at  any  higher  prices  in  the  market  than 
those  commanded  by  the  bonds.  These  facts  are  important,  be- 
cause they  indicate  that  the  actual  rate  of  interest  on  the  capital 
invested  in  these  plants  does  not  appear  to  be  far  from  6  per  cent. 

"Interest  is  justifiable  because  of  the  importauice  of  capital  in 
production,  and  necessary  because  without  it  capital  cannot  be  had 
for  industrial  and  commercial  purposes.  The  rate  of  interest,  as 
determined  by  economic  forces  over  which  individual  borrowers 
have  little  or  no  control,  and  the  effect  of  these  forces,  are  often  best 
measured  by  the  prevailing  rate  in  the  various  undertakings  where 
money  is  obtained  on  the  best  terms  that  can  be  had.      These  terms. 


196  DEVELOPMENT  OF  SCIENTIFIC  RATES 

in  such  cases,  usually  take  into  account  the  risks  involved,  the 
trouble  of  looking  after  the  loans,  the  readiness  by  which  the  loans 
can  be  converted  into  cash  or  withdrawn,  and  other  factors  that 
affect  the  rates  of  interest.  In  this  particular  case  the  position  of 
the  plants,  with  reference  to  the  risks  involved  and  other  factors 
when  compared  with  similar  factors  in  other  industrial  enterprises, 
appears  to  be  about  the  same  as  those  which  obtain,  with  reference 
to  the  rates  of  interest  which  these  plants  pay,  when  these  rates  are 
compared  with  the  rates  of  interest  in  other  industrial  enterprises. 
The  conclusion,  therefore,  must  be  that,  for  the  purposes  of  this 
case,  it  would  hardly  be  fair  to  place  the  rate  of  interest  alone  at 
much  of  anything  below  6  per  cent  on  a  fair  valuation  of  the  plants. 

"The  profits  of  a  business  consist  of  the  balance  between  the 
sum  of  all  expenses  and  the  total  income  of  a  business.  In  other 
words,  it  is  made  up  of  the  difference  between  the  sum  of  the  rent, 
interests,  wages,  and  other  items,  such  as  taxes,  etc.,  and  the  total 
gross  receipts.  This  difference  is  the  last  share  of  the  total  income, 
the  share  of  that  factor  or  of  those  who,  in  the  full  sense,  are  re- 
sponsible for  the  enterprise.  This  share,  like  the  other  shares,  is 
not  fixed.  It  simply  consists  of  what  is  left  after  all  other  claims 
have  been  satisfied.  Rent  and  interest  are  usually  fixed  at  a  certain 
rate  annually,  and  this,  in  a  sense,  is  also  true  of  wages,  salaries  and 
other  expenses.  At  any  rate,  these  amounts  are  fixed  in  advance  and 
are  paid  by  the  employers  or  by  those  who  carry  on  the  business,  out 
of  the  gross  receipts.  The  amount  left,  however,  after  these  shares 
have  been  satisfied,  belongs  to  the  employer  and  represents  his 
share,  or  the  profits  of  the  business.  If  the  balance  left  for  such 
profits  is  large,  then  the  rate  of  profit  is  also  large,  and  vice  versa.  In 
some  cases  the  profits  are  figured  on  the  sales  or  on  the  turnovers;  in 
other  cases,  again,  on  the  year;  but  the  most  common  basis  of  meas- 
urement is  the  investment,  or  the  same  basis  as  that  upon  which 
interest  is  measured.  Interest  and  profits  are  thus  often  measured 
upon  the  same  basis,  and  one  reason  for  this  would  seem  to  be  found 
in  the  fact  that  earlier  writers  on  economics  did  not  always  draw 
any  clear  distinctions  between  these  two  elements. 

"Before  the  advent  of  the  modern  corporation  and  the  present 
facilities  for  credits,  the  capitalist  and  the  employer  were  one  and 
the  same  person.  Business  undertakings  were  then  carried  on  in 
comparatively  small  units.  The  employer  himself  furnished  all  the 
capital,  managed  the  business,  and  assumed  all  the  risks.     In  other 


REASONABLE  PROFIT  197 

words,  he  performed  all  the  functions  for  which  interest  and  profits 
are  received.  Since  the  functions  of  both  capital  and  the  employer 
were  united  in  the  same  person,  there  was,  in  actual  practice,  no 
very  good  reason  for  separating  the  shares  or  compensation  of  these 
two  factors.  Since  the  advent  of  corporations,  systems  of  credits 
and  other  modern  conditions,  all  this  has  changed.  Today  those 
who  have  capital,  but  do  not  prefer  to  risk  it  in  their  own  business, 
usually  loan  it  to  those  who  have  business  abilities  and  are  engaged 
in  industrial  enterprises,  and  who  are  willing  to  pay  the  current 
rates  of  interest  on  such  loans.  Since  the  business  units  have  grown 
so  large  as  is  the  case  at  present,  it  is  usually  found  that  those  who 
have  the  capacity  for  the  successful  operation  of  a  large  undertak- 
ing, but  who  lack  all  or  a  part  of  the  capital  needed,  therefore,  are 
much  more  numerous  than  those  who  have  both  such  capacity  and 
the  requisite  capital.  Hence,  a  condition  has  developed  under  which 
business  is  largely  carried  on  with  borrowed  capital.  Those  who 
furnish  the  capital  receive  interest  thereon.  Those  who  borrow  it 
and  who  use  it  in  their  business  pay  this  interest,  and,  as  compensa- 
tion for  their  services  of  management  and  the  risks  they  assume, 
receive  profits  or  the  surplus  above  the  expenses. 

"This  does  not  mean  that  employers,  as  a  rule,  have  no  capital 
of  their  own  in  the  business  they  are  carrying  on,  for  most  of  them 
have  more  or  less  of  their  own  money  invested  therein.  It  simply 
means  that,  as  a  rule,  the  business  they  are  doing  is  much  too  large 
for  their  own  means,  and  that  they  therefore  find  it  necessary  and 
economical  to  use  the  capital  of  others  as  well  as  that  of  their  own. 
This  has  led  to  a  separation  of  the  functions  of  the  capitalist  and 
the  employer.  The  investors  or  capitalists  are  treated  as  a  class  by 
themselves.  The  employers,  or  those  who  assume  all  the  responsi- 
bilities for  the  management  and  the  risks  of  the  business,  are  treated 
as  a  separate  class.  To  the  extent  the  employers  are  investors  in 
their  business,  they  are  also  regarded  as  capitalists.  In  the  em- 
ployers more  than  one  factor  of  production  is  thus  combined,  and 
they  usually  share  in  the  proceeds  of  the  business  to  the  extent  of 
each  of  these  factors.  The  employers  simply  borrow  from  the  capi- 
talists such  money  as  they  may  need,  and  for  the  use  of  this  money 
pay  stipulated  rates  of  interest  which  vary  with  the  lenders'  esti- 
mate of  the  security  of  the  loan.  This  money,  together  with  their 
own  money,  the  employers  use  in  their  business.  Such  borrowing 
simply  amounts  to  this,  that  the  employers  assume  the  control  and 
risks  of  these  loans  until  they  are  paid  back.     The  employer  is. 


198  DEVELOPMENT  OF  SCIENTIFIC  RATES 

in  fact,  the  owner  of  this  money  in  the  meantime.  He  pays  interest 
thereon  and  also  pays  all  the  other  expenses  of  the  business.  The 
balance  left  after  all  expenses  have  been  met,  if  any,  is  called  profits, 
and  these  profits  constitute  the  employer's  compensation  for  his 
services.  These  are,  in  the  main,  the  facts  which  have  caused  later 
writers  on  business  and  economic  topics  to  enter  upon  a  more  com- 
plete analysis  of  the  functions  of  capital  and  the  employer,  and  of  the 
compensations  which  each  of  these  two  factors  receive  for  the  part 
they  play  in  producing,  marketing  and  selling  the  products. 

"Present  views  upon  these  matters  also  appear  to  be  in  line 
with  the  facts  which  have  thus  been  briefly  outlined.  Profits  are 
now  acknowledged  to  be  a  peculiar  form  of  income  which,  while 
they  differ  from  rent,  wages  and  interest,  occupy  about  the  same 
rank  when  it  comes  to  their  fundamental  importance.  Profits  are 
a  surplus  over  and  above  the  expenses  of  production.  They  are 
usually  identified  as  the  balance  left  over  after  the  claims  of  all 
other  factors  have  been  satisfied,  and  as  the  income  that  goes  to 
those  who  carry  on  the  business.  Those  who  carry  on  the  business, 
or  the  employers  or  entrepreneurs,  as  they  are  usually  called,  are 
regarded  as  co-ordinators  of  the  factors  of  production,  and  as  the 
assumers  of  the  risks  and  responsibilities  of  industrial  undertakings. 
In  other  words,  the  employers  under  modern  conditions  assume,  on 
their  own  responsibilities,  the  difficult  but  important  tasks  of  so 
directing  the  work  of  manufacturing,  marketing  and  selling  the 
products  that  any  given  amount  of  efforts  may  be  most  effective 
in  supplying  human  wants. 

"The  work  of  the  employers  may,  in  a  general  way,  therefore 
be  said  to  consist  of  bringing  together  the  labor  and  capital  that 
may  be  required;  of  arranging  or  laying  the  general  plan  of  the 
business;  of  determining  what  is  to  be  produced  as  well  as  the 
methods  of  production;  of  finding  the  market  and  arranging  for  the 
sale  of  the  products;  they  superintend  or  watch  the  carrying  out  of 
their  plans,  sometimes  in  a  more  general  way  only,  but  often  in  de- 
tail,, depending  upon  the  volume  and  the  nature  of  the  business; 
and  in  addition  to  this  they  also  assume  the  risks  that  are  involved 
in  their  undertakings.  In  other  words,  they  are  the  general  direc- 
tors, and  risk  takers  of  their  businesses.  Their  functions  are,  in 
fact,  so  numerous  and  varied  that  it  is  impossible  in  a  brief  space 
to  even  mention  them  all.  They  could  easily  be  separated  into 
several  distinct  classes. 


REASONABLE  PROFIT  199 

"What  is  true  with  respect  to  the  varied  character  of  the  work 
of  the  employers,  is  also  true  with  respect  to  their  compensation 
for  this  work.  While  this  compensation,  when  considered  as  a 
whole,  is  called  profit,  it  could  undoubtedly,  upon  sufficient  analysis, 
be  divided  up  into  as  many  classes  as  the  work.  To  do  this,  how- 
ever, is  very  difficult.  Profits,  being  a  surplus,  are  not  determined 
by  any  one  set  of  principles.  They  are  the  result  of  the  many  forces 
that  affect  the  prices  at  which  the  products  sell  as  well  as  the  cost 
at  which  they  are  produced.  In  a  general  way,  however,  it  can 
perhaps  be  said  that  profits  are  made  up  of  the  wages  of  manage- 
ments, of  speculative  gains  from  the  risks  which  have  to  be  assumed, 
and  of  gains  such  as  depend  on  chance  rather  than  foresight,  and 
of  gains  due  to  power  of  bargaining  and  other  conditions  of  this 
nature,  including  monopoly  powers. 

*'The  wages  of  management  and  superintendence  are  often  in- 
cluded in  the  operating  expenses.  This  is  especially  true  of  public 
utilities  and  of  most  other  corporations.  When  the  wages  so  paid 
include  full  compensation  for  such  technical  -skill  and  ability  of 
management,  including  the  work  of  planning  the  operations  and 
their  ultimate  direction  as  may  be  required,  and  when  this  compen- 
sation is  included  in  the  operating  expenses,  then  it  is  also  clear 
that  it  should  not  also  be  included  elsewhere  among  the  outlays  or 
under  any  other  head.  Thus,  if  the  cost  of  both  superintendence 
and  management  is  included  as  wages  or  salaries  in  general  ex- 
penses, the  balance  between  the  outlays  and  the  receipts  of  a  plant 
need  not  be  large  enough  to  cover  these  costs.  There  are  many 
cases,  however,  where  all  of  these  costs  are  not  charged  directly 
to  what  is  termed  the  cost  of  operation.  Superintendence,  for  in- 
stance,- may  be  charged  to  this  cost,  while  management  expenses 
may  be  cared  for  out  of  profits.  Again,  a  part  of  these  items  may 
go  into  operating  expenses  and  the  remaining  part  into  profits. 
Practices  in  this  respect  vary  greatly,  not  only  as  between  indus- 
tries, but  as  between  different  plants  in  the  same  industry.  Since 
there  are'  variations  in  the  manner  in  which  these  costs  are  treated, 
it  also  follows  that  before  any  hard  and  fast  conclusions  are  drawn 
from  the  figures  given  in  the  financial  reports  of  such  enterprises, 
it  is  necessary  to  determine  their  practices  in  this  respect.  The 
amount  of  work  falling  upon  the  management  depends  largely  upon 
the  investment,  the  amount  of  business  that  is  done  and  the  nature 
of  the  same.  While  there  are  great  variations  in  this  respect,  it 
can,  perhaps,  be  said  that  the  amount  of  management  that  is  re- 


200  DEVELOPMENT  OF  SCIENTIFIC  RATES 

quired  in  a  business  depends  more  upon  the  circulating  than  on 
the  fixed  capital.  In  industries  where  the  proportion  of  the  former 
is  relatively  large,  the  work  of  the  management  is  also  relatively 
heavy  and  vice  versa.  As  the  cost  of  the  management  bears  a 
somewhat  close  relation  to  the  work,  that  is  required  of  it,  it  also 
follows  that  this  cost  is  comparatively  low  where  by  far  the  larger 
proportion  of  the  investment  consists  of  a  durable  and  easily  man- 
aged plant  which  requires  but  little  attention  after  it  has  been  con- 
structed and  put  in  operation.  Public  utilities  come  in  this  class. 
In  these  the  cost  of  the  management  constitutes  only  a  compara- 
tively small  part  of  the  total  cost  of  the  investment,  although  this  is 
not  always  the  relation  that  exists  between  this  cost  and  the  value 
of  the  products  of  such  utilities. 

"Abilities  of  the  highest  order  are  often  required  for  the  suc- 
cessful operation  or  management  of  a  business  enterprise.  In 
many  industries  really  effective  superintendence  requires  the  high- 
est technical  skill  and  training.  When  it  comes  to  the  management 
proper,  so  much  may  not  be  needed  in  the  way  of  technical  skill, 
but  other  qualities  are  often  required  that  are  even  rarer.  A  man- 
ager, particularly  if  he  is  producing  for  the  general  market,  must, 
first  of  all,  have  a  thorough  knowledge  of  everything  that  concerns 
his  own  business.  He  must  have  the  power  of  forecasting  the 
future,  of  foreseeing  the  broader  movements  that  affect  both  pro- 
duction and  consumption;  of  seeing  where  there  are  opportunities 
for  supplying,  if  not  for  creating  new  wants;  of  being  able  to  im- 
prove old  methods  of  production  as  well  as  the  products  that  are 
made  for  the  market.  The  manager  must  be  a  good  and  cautious 
judge  not  only  of  the  present,  but  also  of  the  future.  In  addition  to 
this  he  must  also  be  a  leader  of  men,  able  to  choose  efficient  and  con- 
scientious assistants  whom  he  can  trust  and  rely  upon,  as  well  as  of 
interesting  them  in  their  work  so  as  to  bring  out  the  best  there  is  in 
them.  While  doing  all  this,  he  must  be  able  to  exercise  general 
control  and  to  see  to  it  that  the  main  plans  are  adhered  to  in  the 
business  as  a  whole,  and  to  so  engineer  the  different  processes  that 
the  products  are  turned  out  at  costs  that  are  low  enough  so  that  they 
may  be  sold  at  profits.  All  this  requires  a  high  order  of  ability, 
judgment,  tact  and  determination,  qualities  that  are,  perhaps  more 
dependent  upon  *  natural  capacity  than  upon  technical  training. 
There  are,  of  course,  many  industries  which  are  operating  under 
favorable  conditions  and  where  the  duties  of  the  employer  are  less 
exacting.     The  products  they  supply  are  simple  and  require  little 


REASONABLE  PROFIT  201 

change.  The  methods  by  which  they  are  produced  are  uniform, 
well  settled  and  do  not  require  the  highest  technical  skill.  The  mar- 
kets in  which  these  products  are  sold  are  also  well  established  and 
defined.  In  such  cases  the  operation  of  the  plants  is  often  reduced 
to  merely  routine  work.  This  is  the  situation  for  some  of  the  public 
utilities  and  for  many  other  undertakings. 

"While  the  work  of  the  management  is  among  the  highest 
classes  of  work  that  is  performed  in  connection  with  any  enter- 
prise and  often  requires  the  greatest  ability  in  order  to  attain  suc- 
cess, it  is  a  fact  that  managerial  ability  is  not  as  scarce  as  may 
appear  to  be  the  case  at  the  first  blush.  In  our  present  commercial 
and  industrial  processes  a  class  of  men  are  constantly  being  devel- 
oped who  appear  to  be  quite  able  to  fill  these  positions  as  they 
become  vacant  or  are  created.  The  result  of  this  is,  that  the  supply 
of  almost  all  grades  of  managerial  ability  is,  in  most  cases,  equal  to 
the  demand.  In  view  of  these  facts  it  is  also  obvious  that  the  cost 
of  this  class  of  service  is  a  matter  that  is  not  entirely  independent 
of  ordinary  competitive  conditions. 


"Whether  the  executive  expenses  in  this  case  are  unreasonably 
high,  is  something  that  can  be  determined  with  only  approximate 
accuracy.  In  passing  upon  this  question  the  size  of  the  plants, 
their  earnings  and  expenses,  the  conditions  under  which  they  are 
operating,  the  grade  of  men  required  for  safe  and  effective  opera- 
tion, are  all  matters  that  should  be  carefully  considered.  The 
larger  the  plant  the  more  numerous  the  customers,  the  more  is  re- 
quired of  the  management.  High-grade  service  safely  rendered 
may  also  require  greater  efficiency  on  the  part  of  the  management 
than  if  the  standard  of  the  service  were  lower.  When  the  salaries 
are  fixed  with  these  conditions  in  mind,  and  no  more  is  paid  than 
the  amount  that  is  suflBcient  to  insure  proper  and  efficient  service, 
there  is  little  to  be  said  regarding  the  salaries  paid.  If,  on  the  other 
hand,  the  salaries  are  kept  at  an  unreasonably  high  level  in  order 
to  cover  up  earnings,  or  for  some  other  reason  of  this  nature,  there 
may  be  good  ground  for  criticisms. 


"As  already  pointed  out,  the  greatest  risks  usually  prevail  in 
competitive  undertakings.  In  these  there  is  a  constant  struggle 
between  the  competitors  to  reduce  the  cost  of  production  and  to 


^02  DEVELOPMENT  OF  SCIENTIFIC  RATES 

bring  about  other  changes  that  will  give  them  some  advantage  in  the 
markets.  Such  producers  have  no  way  of  controlling  the  supply  of 
their  products;  and  since  the  prices  of  the  same  are  therefore  be- 
yond their  control,  they  are  apt  to  suffer  from  any  improvement 
in  the  method  of  production  on  the  part  of  any  of  their  competi- 
tors that  tends  to  either  reduce  the  cost  of  these  products  or  to  en- 
hance the  demand  for  them  in  the  market.  The  uncertainties 
or  risks  that  are  arising  from  these  and  similar  sources  are  often 
extremely  great.  Even  the  ablest  and  most  foreseeing  of  the  pro- 
ducers are  often  taxed  to  the  utmost  in  holding  their  own  in  the 
market.  In  cases  where  they  are  protected  by  patent  rights  or 
enjoy  other  advantages  of  this  nature,  the  risks  are,  of  course,  some- 
what reduced.  But  the  security  which  is  derived  from  such  sources 
is  not  permanent.  Patent  rights  expire.  Improvements,  both  in 
organization  and  in  methods  and  machinery,  are  constantly  going 
on.  Advantages  of  this  kind  are,  therefore,  apt  to  disappear  at 
almost  any  moment. 

"In  industries  where  certain  monopoly  conditions  prevail,  such 
as  public  utilities,  competitive  risks  are,  of  course,  of  much  smaller 
importance.  In  such  industries  the  supply  is  under  control  and 
there  is  no  direct  competition  in  the  sale  of  their  products  or  services. 
There  are,  of  course,  exceptions  to  this,  but  these  are  not  frequent, 
nor  often  serious  or  permanent.  But  when  direct  competition  ex- 
ists between  such  utilities,  it  is  in  the  very  nature  of  things  most 
destructive.  It  means  serious  losses  to  all  the  competitors,  and  if 
continued  for  some  time,  ruin  to  one  or  the  other.  It  is  for  these 
reasons  that  such  competition  is  usually  short-lived,  and  that  it  soon 
ends  either  in  the  consolidation  of  the  competing  companies  or  in 
agreements  between  them  of  some  sort,  under  which  prices  are 
restored  and  maintained.  But,  as  said,  such  conditions  are  now  not 
very  frequent.  Water  works  have  little  or  no  other  direct  competi- 
tion to  contend  against  than  such  water  supplies  as  may  be  obtained 
from  wells  and  nearby  rivers  and  lakes,  and  such  competition  is  not 
often  serious  enough  to  materially  affect  conditions.  This  is  also, 
in  the  main,  true  for  gas  and  electric  companies,  although  these 
compete  some  as  between  each  other.  When  they  have  exclusive 
franchises,  they  can  meet  with  no  direct  competition,  and  even 
when  their  franchises  are  not  expressly  exclusive  they  are  often 
practically  so  in  effect.  Both  may  suffer  some  from  such  substi- 
tutes as  oils  and  acetylene  plants,  but  even  such  competition  is  sel- 
dom met  with  as  long  as  rates  are  held  down  to  reasonable  limits. 


REASONABLE  PROFIT  203 

Gas  and  electric  current  used  for  power,  have,  of  course,  to  contend 
against  each  other  as  well  as  against  steam,  but  the  seriousness  of 
this  is  usually  materially  reduced  by  the  fact  that  each,  to  a  certain 
extent,  has  a  field  of  its  own  to  supply.  That  is,  there  are  certain 
demands  for  power  in  each  case  that  are  best  serv^ed  by  one  or  the 
other  of  the  utilities  mentioned,  or  in  which  each  has  some  advan- 
tage over  the  other.  In  considering  everything,  therefore,  these 
utilities  do  not  appear  to  be  as  great  sufferers  from  either  direct  or 
indirect  competition,  as  is  the  case  in  most  competitive  undertakings. 

"But  there  are,  in  public  utilities  as  well  as  in  other  industries, 
other  than  competitive  risks.  In  the  construction  and  operation  of 
such  plants  many  accidents  may  be  met  with  and  many  mistakes 
may  occur.  While  some  of  these  might  have  been  foreseen  and 
prevented,  others  may  be  beyond  human  intelligence  and  grasp. 
Many  examples  of  this  might  be  mentioned.  Such  plants  may  also 
be  injured  bj^  the  diversion  of  the  growth  of  the  city  in  a  different 
direction  from  that  expected  when  the  plants  were  built;  by  the 
failure  of  the  city  to  grow  as  rapidly  as  expected  or  as  rapidly  as 
the  plant  had  made  preparations  for;  by  the  failure  of  the  city  to 
grow  at  all,  as  well  as  by  decreases  in  its  population  and  industries; 
by  actions  of  the  local  and  other  authorities  by  which  unprofitable 
extension  may  be  required,  the  rates  reduced  or  other  burdens  im- 
posed, as  public  utilities  usually  have  to  furnish  adequate  service 
whether  it  is  paying  or  not.  In  the  case  of  such  losses  the  owners 
or  employers  are  the  first  to  suffer,  as  their  share  of  the  proceeds  is 
not  fixed,  but  has  to  take  what  is  left  after  the  other  claims  have  been 
met.  Wages,  salaries,  supplies,  taxes,  interest  on  the  bonds  or  notes, 
etc.,  must  be  paid  by  the  employers  or  the  business  will  stop  or  go 
into  receivership.  If  the  earnings  are  only  large  enough  to  cover 
these  outlays,  the  employer  will  have  to  go  without  his  pay.  There 
is  no  escape  from  this.  In  view  of  these  and  other  facts,  it  is  clear 
that  public  utilities  are  not  entirely  exempted  from  risks  and  that, 
therefore,  there  is  a  speculative  feature  about  them  for  which  their 
owners  are  entitled  to  something  in  the  way  of  speculative  gains. 

"To  state  even  approximately  what  the  speculative  gains  or  the 
compensations  for  the  risks  which  employers  assume  for  society 
should  amount  to  in  the  various  industries,  is,  of  course,  diflScult. 
The  data  so  far  collected  upon  these  points  are  not  as  complete  as 
they  might  be.  Comparatively  few  enterprises  issue  regular  reports 
showing  their  earnings  and  expenses  in  detail.  Those  which  issue 
such  reports  usually  show  the  total  profit  in  a  lump  sum,  making 


204  DEVELOPMENT  OF  SCIENTIFIC  RATES 

no  attempts  to  separate  this  item  among  its  constituent  elements. 
In  fact,  the  classification  of  the  various  property  earnings,  expense 
and  other  items  on  the  records  of  most  enterprises  is  quite  likely 
to  differ  from  the  classification  of  these  elements  by  economists. 
But  while  all  this  is  true,  it  is  nevertheless  a  fact  that  there  are  few 
elements  in  any  business  concerning  which  a  fairly  reliable  informa- 
tion cannot  be  had  if  the  proper  efforts  are  made  to  obtain  them. 
A  close  study  and  observation  of  the  actual  facts  in  the  business 
world,  as  well  as  of  the  reports  in  which  the  results  of  the  various 
business  operations  are  summarized,  can  hardly  fail  to  throw  a 
great  deal  of  light  upon  questions  of  this  character. 

'Tn  monopolistic  industries  the  average  profits  are  often  greater 
than  in  competitive  ones.  That  this  should  be  the  case  is  only 
natural,  for  the  former  control  the  supply  of  their  products  and 
are,  therefore,  quite  generally  in  position  to  charge  such  prices  for 
the  same  as  will  yield  the  greatest  net  returns.  In  fact,  the  chief 
peculiarity  of  monopoly  prices  is  found  in  the  control  which  mon- 
opolies have  over  the  supply.  In  other  words,  the  former  are  gov- 
erned through  the  control  of  the  latter.  In  competitive  industries 
the  magnitude  of  the  profits  depends  on  the  managing  ability,  fore- 
sight, bargaining  skill  and  good  fortune  of  the  employers.  In 
monopolistic  industries  profits  rest  on  these  qualities  as  well  as  on 
an  additional  element  which  is  of  the  greatest  importance,  namely, 
the  ability  of  the  monopolist  to  control  the  supplj^  which  usually 
results  in  fixing  prices  at  the  point  where,  as  said,  they  will  yield  the 
highest  net  profits.  Competitive  profits  tend  towards  the  minimum; 
monopoly  profits  tend  towards  the  maximum.  The  latter  profits 
are  also  apt  to  have  greater  stability  than  the  former.  This  applies, 
in  varying  degrees,  to  all  kinds  of  monopoly  advantages,  or  to  public 
utility  corporations  as  well,  to  good  will,  patent  rights  and  other 
privileges  of  this  character. 

"Regardless  of  these  facts,  there  appear  to  be  many  enterprises 
of  a  monopolistic  nature,  such  as  public  utilities,  that  are  not  even 
earning  the  average  profits,  but  are  actually  losing  money  from 
year  to  year.  That  this  is  the  case  is  clearly  shown  by  their  financial 
reports  and  records.  In  some  instances,  this  is  due  to  lack  of  cus- 
tomers, or  to  the  fact  that  the  places  where  the  utilities  are  located 
are  too  small  to  furnish  the  requisite  number  of  customers  or  volume 
of  sales  that  are  necessary  for  a  paying  business.  In  other  cases, 
again,  it  is  due  to  such  adjustment  to  the  rate  schedules  that  the 


REASONABLE  PROFIT  205 

proper  extension  of  the  business  is  effectively  prevented.  In  still 
other  cases  it  is  found  in  the  fact  that  the  rates  charged  are  too  low 
to  yield  a  profit.  This  is  sometimes  the  case  when  the  rates  are 
fixed  by  the  municipality.  In  some  cases  such  losses  are,  therefore, 
due  to  conditions  that  may  be  removed  through  more  efficient  man- 
agement and  more  equitable  rate  schedules,  while  in  other  instances 
they  seem  to  be  beyond  remedy  until  the  places  which  the  utilities 
are  serving  have  attained  their  proper  growth  of  development. 

"But  while  many  public  utilities  are  losing  money,  there  are  also 
a  great  many  of  them  that  are  making  good  profits.  While  these 
profits  are  not  often  as  large  as  appears  to  be  the  general  belief, 
they  are  often  above  what  appears  to  be  the  average  run  of  profits 
in  many  other  industries.  A  close  examination  of  a  great  many 
financial  reports  show  that,  while  some  utilities  are  not  earning  their 
operating  expenses,  including  the  wages  of  management  and  inter- 
est on  the  investment  at  current  rates,  others  are  earning  a  great 
deal  more  than  this.  The  present  situation,  therefore,  is,  that  the 
speculation  and  other  gains  vary  from  nothing  up  to  sums  that 
amount  to  several  per  cent  on  the  investment.  Just  what  the  aver- 
age speculative  gains  of  gas  and  electric  plants  amount  to  at  present, 
is,  therefore,  a  matter  that  is  difficult  to  estimate.  ^Miere  such 
gains  actually  exist,  they  appear  to  amount  to  sums  that  vary  from 
1  to  10  or  more  per  cent  on  the  investment.  When  interest  on  the 
investment  is  figured  at  6  per  cent,  there  are  plants  that  show  a 
surplus  above  this  that  runs  up  to  about  a  like  amount  on  what 
appears  to  be  fair  valuations  of  the  plants.  As  gas  and  electric 
plants,  generally  speaking,  may  be  regarded  as  fairly  safe  enter- 
prises, especially  after  they  have  once  reached  a  paying  basis,  safer 
in  fact  than  many  competitive  undertakings,  the  speculative  gains 
in  the  former  should  also  be  measured  by  a  lower  standard  than 
those  which  prevail  for  the  latter.  While  this  is  true  as  a  general 
proposition,  it  does  not  apply  in  every  case,  nor  is  it  always  the 
\new  investors  take  of  it.  The  plants  in  question  here,  however,  are 
favorably  situated.  Their  earnings  appear  safe  and  are  gradually 
growing  larger,  and  they  enjoy  fairly  good  credit,  which  is  indi- 
cated by  the  prices  at  which  their  bonds  are  selling. 

"The  processes  of  the  equipment  involved  in  producing  and 
delivering  gas  to  consumers  are  usually  assumed  to  be  more  fully 
developed  and  subject  to  fewer  changes  than  the  processes  and 
equipments  that  are  involved  in  producing  and  delivering  electricity. 
As  these  assumptions  appear  to  be  in  accordance  with  the  facts,  it 


206  DEVELOPMENT  OF  SCIENTIFIC  RATES 

would  also  seem  to  follow  that  the  risks  involved  are  somewhat 
lower  for  gas  than  for  electric  plants  and  that,  for  this  reason,  the 
latter  kind  of  plants  are  entitled  to  somewhat  greater  profits  than 
the  former.  Just  what  this  difference  should  amount  to,  is  a  ques- 
tion that  largely  depends  upon  the  conditions  in  each  case  and  con- 
cerning which  no  general  rules  can  be  laid  down  that  are  likely  to 
amount  to  a  great  deal. 

"In  view  of  the  facts  that  have  thus  been  presented  in  relation 
to  this  subject,  it  may  be  said  that  the  witnesses  for  the  respondent 
placed  that  part  of  the  return  on  the  investment  which  might  prop- 
erly be  termed  profits  at  rather  high  figures;  and  that  under  the 
circumstances  in  this  case  it  is  not  unreasonable  to  limit  the  profits  to 
from  13^  to  2  per  cent  on  a  fair  valuation  of  the  gas  plant  and  from 
2  to  23^  on  a  fair  valuation  of  the  electric  plant.  Such  rates,  in 
addition  to  an  allowance  of  6  per  cent  in  each  case  for  interest, 
would  seem  to  be  fair  to  the  present  owners  as  well  as  sufficient  to 
secure  both  the  business  capacity  and  capital  that  are  required  in 
this  particular  case.  It  would  not  be  unreasonable  to  limit  the  re- 
turns for  both  interest  and  profit  to  not  less  than  from  73^2  to  8 
per  cent  on  a  fair  valuation  of  the  gas  plant,  and  to  not  less  than  8 
per  cent  on  a  fair  valuation  of  the  electric  plant. 

"Profits  often  also  contain  other  elements  of  gain,  such,  for  in- 
stance, as  are  derived  from  unforeseen  and  fortuitous  circumstances 
and  from  superior  power  of  bargaining.  The  former  of  these  two 
classes  of  gains  would  rather  seem  to  be  the  result  of  chance.  They 
depend  upon  sudden  changes  in  the  demand,  temporary  shortages  of 
goods  on  the  part  of  competitors,  and  other  conditions  of  this  nature, 
rather  than  on  foresight  and  good  business  judgment.  Such  gains, 
nevertheless,  are  often  of  considerable  importance  and  may  be  of 
material  aid  in  the  success  of  an  enterprise.  The  gains  of  bargain- 
ings are  also  often  of  the  greatest  importance.  They  consist  of  the 
ability  to  buy  at  the  lowest  and  sell  at  the  highest  possible  prices. 
In  actual  practice  it  often  happens  that  the  shrewder  one  of  the 
bargaining  parties  can  sell  for  higher  than  his  lowest  price  and  buy 
for  lower  prices  than  those  he  might  have  been  ready  to  pay,  and 
that  his  advantages  in  these  respects  are  simply  due  to  the  fact  that 
he  has  the  ability  to  derive  the  closest  bargains.  These  powers  may 
be  due  to  greater  natural  capacity,  to  better  and  more  complete  in- 
formation upon  the  matters  involved,  and  to  several  other  causes. 
In  any  event,  it  is  a  valuable  power  to  possess,  as  it  frequently  leads 
to  considerable  increases  in  the  profits  of  a  business. 


REASONABLE  PROFIT  207 

"In  passing  upon  these  matters,  however,  it  should  be  borne  in 
mind  that  under  present  industrial  conditions  the  best  interests  of 
society,  as  a  whole,  are  subserved  when  the  share  of  each  factor  of 
production  is  high  enough  to  cause  a  free  and  unrestricted  flow  of 
labor,  capital  and  business  ability  into  the  various  utilities.  If 
wages,  interest  and  profits  are  not  high  enough  to  attract  the  factors 
which  they  represent,  then  these  factors  will  not  enter  the  utility 
business.  The  result  of  this  is  clear.  If  either  or  all  of  the  factors 
refuse  to  enter  this  field,  then  no  service  of  the  kind  these  utilities 
render  w^ll  be  furnished,  and  the  people  may  have  to  forego  what 
may  have  become  necessities  to  them.  In  order  to  obtain  such  serv- 
ice, therefore,  it  is  absolutely  necessary  that  the  wages  paid  should 
be  high  enough  to  attract  competent  workmen,  superintendence  and 
management;  that  the  interest  paid  on  the  capital  legitimately  in- 
vested should  be  sufficient  to  attract  the  necessary  capital  into  these 
enterprises;  and  that  the  speculative  and  other  gains  should  be 
high  enough  to  induce  employers  to  enter  these  industries  as  co- 
ordinators of  the  other  factors  of  production  therein  and  as  assum- 
ers  of  all  risks  and  responsibilities  that  are  involved  in  their  opera- 
tion. From  these  facts  there  is  no  escape.  From  this  it  also  fol- 
lows that  the  rates  fixed  for  the  services  rendered  by  such  utilities 
must,  in  the  long  run,  be  high  enough  to  attract  the  various  factors 
of  production,  or  to  induce  the  employer  to  enter  upon  such  enter- 
prises and  to  become  responsible  for  the  risks  that  are  involved.'* 


Extract  from  Opinion  of  Massachusetts  Board  of 
Gas  and  Electric  Light  Commissioners 

In  re  Charlestown  Gas  and  Electric  Company's  Gas  Rates 

On  June  27,  1910,  the  Massachusetts  Gas  and  Electric  Light 
Commission  made  an  order  reducing  the  price  of  gas  sold  hy  this 
Company  from  ninety  cents  to  eighty-five  cents,  the  reduction  to 
take  effect  August  1st,  1910.  The  price  of  gas  furnished  by  the 
Boston  Consolidated  Gas  Company  was  eighty  cents,  and  that  sold 
by  the  Cambridge  Gas  Light  Company  was  eighty-five  cents.  Both 
the  Charlestown  Company  and  the  Cambridge  Company  had  been 
paying  annual  dividends  of  ten  per  cent.  The  outstanding  capital 
stock  of  the  Charlestown  Company  was  greater  in  proportion  to  its 
output  than  that  of  the  Cambridge  Company,  and  was  also  larger  in 
proportion  to  book  values,  and  apparently  to  the  actual  values  of 
their  respective  plants. 

In  its  decision  the  Commission  said: 

"The  decisions  of  the  courts  seem  to  establish  clearly  that  a  company's 
reasonable  rate  of  profit  is  not  to  be  based  upon  the  volume  of  its  out- 
standing securities,  but  is  dependent  rather  upon  the  actual  value  of  the 
plant  devoted  to  the  public  use.  Whatever  may  be  a  fair  and  reasonable 
rate  of  return  to  either  company  on  this  basis,  it  does  not  necessarily 
require  that  it  must  be  sufficient  to  maintain  the  same  rate  of  dividend  in 
both.  The  Cambridge  price  and  dividend,  made  as  they  are  voluntarily 
by  the  company,  may  be  assumed  to  be  not  unreasonably  low.  The 
Charlestown  dividend  is  only  fair  when  it  can  be  earned  with  a  reasonable 
price.  Under  most  conditions  a  fair  and  reasonable  rate  of  dividend  is  a 
very  important  factor  in  determining  a  reasonable  price.  Under  other 
circumstances  other  factors  may  be  of  greater  importance. 

"In  an  inquiry  like  this,  the  board  must  determine  what  price  is  reason- 
able, not  merely  for  the  stockholders,  but  for  the  public,  in  view  of  all  the 
circumstances  surrounding  the  case.  The  public  is  in  any  case  entitled 
to  the  lowest  reasonable  price  at  which  a  company  can  afford  its  service, 
irrespective  of  prices  elsewhere.  But  this  is  not  the  only  rule  to  be  con- 
sidered, for  in  process  of  time  and  under  some  conditions,  a  certain  standard 
of  prices  may  become  so  well  established,  that  a  company  may  be  bound  to 
meet  it,  even  though  such  action  may  involve  some  risk  to  the  continuance 
of  a  well-established  and  otherwise  not  unfair  return.  Although  com- 
panies of  this  class  may  exercise  a  practical  monopoly  within  their  res- 
pective areas  of  supply,  they  are  not  wholly  relieved  from  the  competitive 


REASONABLE  PROFIT  209 

force  of  rates  elsewhere.  The  reason  which  apparently  led  the  Charles- 
town  company  to  reduce  its  electric  prices,  both  for  public  and  commercial 
lighting,  to  the  level  of  those  in  other  parts  of  Boston,  are  a  virtual  recog- 
nition of  the  truth  in  these  propositions. 

'*In  view  of  the  decrease  in  the  company's  electric  income  and  the  in- 
crease in  expenses  already  noted,  a  reduction  in  the  price  of  gas  may  have 
some  temporary  effect  upon  the  present  rate  of  dividend.  It  may,  never- 
theless, be  confidently  expected  that  the  price  named  will  yield  under  all 
circumstances  a  reasonable  return  upon  the  value  of  the  property  which  the 
company  is  employing  for  the  supply  of  gas  in  the  territory  which  it  serves. 
The  board  is  not  con\'inced  that  under  present  conditions  the  Boston  price 
is  a  reasonable  price  for  Charlestown.  On  the  other  hand,  the  board  has 
reached  the  conclusion  that  the  Charlestown  company  may  no  longer 
reasonably  charge  its  customers  more  than  the  present  price  in  Cambridge, 
and  a  part  of  Somerville,  and  that  there  is  nothing  in  the  present  condition 
of  the  company's  affairs  or  in  its  future  prospects  to  render  such  a  reduction 
commercially  impracticable  or  inexpedient." 


New  York  Public  Service  Commission, 
Second  District 

In  re  Application  of  Rochester,  Corning,  Elmira  Traction 
Company  for  Authority  to  Issue  Bonds  and  Stock 

Second  Ann.  Report  (for  1908),  pp.  20,  155,  179,   182. 

In  this  matter  (March,  1908),  the  Commission  passed  upon  the 
appHcation  of  the  Traction  Company,  a  newly  organized  railroad, 
for  authority  to  issue  mortgage  bonds  and  capital  stock,  and  laid 
down  the  following  rules  for  the  division  of  the  capitalization  be- 
tween stock  and  bonds  to  be  applied  whenever  practicable: 

"(1)  An  estimate  will  be  made,  from  consideration  of  the  results  of 
operation  of  existing  roads,  of  the  probable  gross  earnings.  , 

(2)  An  estimate  will  be  made  in  like  manner  of  the  probable  operating 
expenses,  taxes  and  depreciation  charges. 

(3)  The  excess  of  earnings  over  the  disbursements,  which  must  be 
made  before  fixed  charges  can  be  met,  represents  the  sum  which  is  applica- 
ble to  fixed  charges. 

(4)  The  maximum  bond  issue  which  will  be  allowed,  mUst  be  deter- 
mined by  the  sum  thus  ascertained  to  be  applicable  to  the  payment  of  the 
interest  charge. 

(5)  No  bond  issue  should  be  permitted  creating  an  interest  charge 
beyond  an  amount,  which  it  is  reasonably  certain  can  be  met  from  the  net 
earnings. 

(6)  Stock,  representing  a  cash  investment,  should  be  required  to  an 
amount  sufficient  to  afford  a  moral  guaranty,  that  in  the  judgment  of  those 
investing,  the  enterprise  is  likely  to  prove  commercially  successful." 

On  rehearing  (p.  179)  bonds  were  authorized  to  be  issued  to 
the  extent  of  $1,000,000  to  be  sold  at  not  less  than  85%  (p.  155) 
when  stock  to  the  amount  of  $380,000  had  been  subscribed  by  re- 
sponsible parties,  and  such  subscription  proved  to  the  Commission. 


Extract  From  the  Opinion  of  the  Massachusetts 
Board  of  Gas  and  Electric  Light  Commissioners 

In  the  matter  of  Rates  of  Edison  Electric  Illuminating  Company 

of  Boston 

(24th  Annual  Report,  p.  20) 

Here  the  Public  Franchise.  League  of  Boston  claimed  that  the 
rates  of  the  Boston  Edison  Company  were  exorbitant  and  discrimi- 
nating, and  that  the  rate  system  was  intricate,  complex,  and  not 
generally  understood.  Hearings  in  the  matter  by  the  Commission 
were  had  from  February,  1907,  to  November,  1907. 

The  theory  of  the  Company's  rates  was  claimed  by  it  to  be,  to 
charge  each  customer  substantially  the  cost  to  it  of  supplying  him, 
including  a  reasonable  return  on  the  investment  made  in  his  behalf; 
in  other  words,  the  basis  was  the  cost  of  service  to  each  individual 
customer.  The  Company  claimed  that,  "the  costs  of  an  electric 
lighting  company  are  actually  the  sum  of  what  its  customers'  costs 
would  be,  if  they  supplied  themselves  under  the  different  conditions 
under  which  they  consume  current,  less  such  deduction  as  is  justified 
by  the  use  of  the  same  plant  by  different  customers,  and  such  de- 
duction as  is  justified  by  the  greater  economy  of  the  company's 
larger  plant." 

The  commission  held  that  the  justification  of  a  system  of  in- 
dividual rates  must  rest  upon  the  practicability  of  ascertaining,  with 
reasonable  accuracy,  the  cost  of  supplying  each  individual  customer, 
and  of  automatically  apportioning  this  cost  to  him  by  the  schedule 
of  prices  adopted;  further,  that  the  Company  should  be  able  to 
demonstrate  that  it  is  possible  to  ascertain  individual  costs  with 
reasonable  accuracy.  The  Commission  was  of  the  opinion  that  no 
differential  system  of  rates  for  a  public  utility  could  be  equitably 
and  properly  based  solely  upon  the  cost  to  the  Company  of  supply- 
ing the  individual.  It  stated  that  it  was  not  convinced  that  it  was 
practicable,  ev^n  though  desirable,  to  ascertain  the  respective  costs 
to  the  Company  of  its  individual  customers,  and  to  apportion  such 
cost  in  the  prices  charged,  either  under  the' system  used  by  the 
Company,  or  under  any  other  known  to  the  Board. 


212  DEVELOPMENT  OF  SCIENTIFIC  RATES  , 

The  conclusion  of  the  Board  was,  that  the  Company  should 
offer  to  sell  electricity  for  any  use  at  a  uniform  price,  not  to  exceed 
12c  per  kw.  hour,  and  that  if  a  customer  should  elect  to  be  served 
under  the  existing  schedule,  whenever  the  average  price  per  kw. 
hour  charged  to  him  for  any  year  exceeded  such  uniform  price,  his 
account  should  be  adjusted  so  that  he  should  not  pay  more  than 
such  uniform  price. 

The  Company  was  left  free  to  establish  lower  rates  for  service 
to  customers,  who  were  in  a  position  to  otherwise  serve  themselves. 
In  other  words,  rates  based  on  the  demand  system  might  continue 
to  be  offered  in  order  to  get  competitive  business.  The  Commis- 
sion in  its  decision  said: 

"A  kilowatt  hour  is  now  the  established  unit  for  measuring  electricity. 
It  represents  a  definite  amount  of  electrical  energy.  It  will  do  exactly  the 
same  amount  of  work  for  one  customer  as  for  another.  Unless  a  customer 
can  consider  seriously  generating  his  own  electricity,  the  value  to  him  of 
each  kilowatt  hour  furnished  by  the  company  has  no  necessary  relation 
either  to  demand,  quantity  or  length  of  use.  If,  however,  he  can  seriously 
consider  supplying  himself,  these  factors  may  affect  his  own  cost,  and 
therefore  the  price  which  he  might  be  willing  to  pay  the  company  instead 
of  installing  his  own  plant. 

"In  the  second  place,  the  use  of  electricity  for  light  and  power  has 
grown  with  great  rapidity  during  the  past  two  decades,  and  while  it  may 
be  generated  and  used  even  in  small  quantities  on  private  premises,  yet 
as  a  practical  matter  it  is  impossible  for  every  individual  to  manufacture 
electricity  for  himself.  Most  of  the  members  of  a  community  must  seek 
a  supply  from  some  common  agency,  or  not  enjoy  its  use.  To  serve  this 
need,  and  to  promote  the  public  welfare  and  convenience,  the  company 
has  been  given  substantially  exclusive  privileges  to  extend  its  lines 
throughout  the  territory  which  it  supplies.  # 

"The  company  has,  therefore,  a  public  duty  to  perform,  and  is  bound 
to  discharge  this  duty  for  the  equal  benefit  of  all.  It  is  also  to  be  remem- 
bered that  it  has  but  one  service  to  render  its  customers,  namely,  to  supply 
them  with  electricity.  The  company  conceded  that  it  cannot,  consistently 
with  its  duty  to  the  community,  supply  A  and  refuse  to  supply  B,  both 
being  within  reach  of  its  lines.  It  is  equally  clear  that  to  charge  A  one 
price  and  B  another  for  the  same  service  under  like  conditions  is  a  violation 
of  duty.  In  a  proper  conception  of  the  nature  of  this  duty,  mere  difference 
in  size  of  customers  does  not  of  itself  constitute  such  a  difference  in  con- 
ditions as  to  justify  a  difference  in  price.  But  the  company  contended 
that  in  any  event  variations  in  length  of  use  of  a  given  demand  constitute 
such  differences  in  condition  as  to  warrant  differences  in  price.  Here 
again,  however,  it  is  plain  that  such  differences  in  price  must  be  justified, 
if  at  all.  because  of  reasonably  proportional  differences  in  cost  of  service, 
and  yet  it  has  already  been  set  forth  that  this  consideration,  even  on  the 


REASONABLE  PROFIT  213 

company's  theory,  must  frequently  yield  to  considerations  of  the  nature 
of  the  customer's  use  of  electricity,  and  that  at  best  the  company  can  as- 
sign the  costs  of  supplying  its  customers  only  on  broad  lines,  and  upon  cer- 
tain general  assumptions  and  averages.  Due  weight  should  be  and  has  been 
given  to  the  necessity  and  desirability  of  increasing  the  efficiency  of  the 
plant  without  increasing  the  investment,  in  order  thereby  to  decrease  the 
average  cost  of  the  electricity  produced.  It  may  be  admitted  as  a  general 
truth  that,  other  conditions  being  equal,  length  of  use  of  a  given  demand 
has  an  influence  upon  the  company's  costs.  But  unless  the  variations  in 
use  are  sufficiently  marked,  it  is  apparent  that  their  influence  upon  costs 
is  slight,  and,  therefore,  with  respect  to  the  great  majority  of  customers 
they  are  practically  negligible.  The  Board  is  also  not  convinced  that  this 
consideration  is  so  controlling  as  to  warrant  the  conclusion  that  such 
conditions  necessarily  create  individual  differences  in  cost  upon  which 
different  prices  to  customers  may  properly  be  based. 

"If  all  the  customers  of  the  company  were  dependent  upon  it  for  a 
supply,  it  is  believed  that  there  would  be  little  occasion  to  discuss  or 
attempt  to  justify  differential  rates,  and  that  a  uniform  meter  rate,  deter- 
mined by  reasonable  operating  costs  and  a  fair  return  on  the  investment 
reasonably  necessary  for  the  public  convenience,  would  prevail  universally. 
It  may  be  conceded  that,  if  a  uniform  meter  rate  prevailed,  there  would 
be  some  unprofitable  customers.  This  may  be  predicated  with  truth  of 
any  system  of  rates  for  a  public  service.  The  Board  is  of  the  opinion, 
however,  that  this  view  of  such  a  rate  is  exaggerated,  and  that  in  any 
event  it  is  likely  to  result  in  no  greater  amount  of  injustice  than  in  an 
attempt  to  make  every  customer  theoretically,  if  not  actually,  profitable. 
There  can  be  no  more  desirable  requisite  for  every  public  service  charge 
than  that  it  shall  be  simple,  definite  and  readily  understood  and  applied 
Even  its  most  ardent  advocates  do  not  claim  that  these  characteristics 
are  inherent  in  the  demand  system. 

"In  an  analysis  of  the  last  year  of  the  company's  business,  the  non- 
contract  lighting  customers  were  in  point  of  numbers  15,000  out  of  20,000 
approximately,  or  75  per  cent  of  the  whole  number  of  customers.  ***** 
Those  customers  who  cannot  manufacture  electricity  for  themselves,  and 
whose  needs  and  convenience  the  company  is  bound  to  serve,  are  chiefly 
of  this  non-contract  class.  Whatever  view  may  be  taken  of  the  matter, 
the  conditions  under  which  customers  so  situated  use  electricity  are  not 
so  unlike  as  to  make  a  uniform  meter  rate  work  any  substantial  injustice 
to  them.  Neither  is  there  any  sufficient  advantage  to  the  company,  in 
the  present  system  of  rates  as  applicable  to  this  class,  to  compensate  for 
the  complications  and  misunderstandings  which  they  introduce.  The  board 
is  of  the  opinion  that,  in  view  of  these  considerations  and  in  place  of  the 
present  so-called  non-contract  lighting  rates,  the  company  should  offer  to 
sell  electricity  to  its  customers  for  any  use  at  a  uniform  meter  rate. 

"In  distinction  from  the  large  body  of  customers  just  mentioned  there 
is  a  considerable  number,  both  actual  and  possible,  who  may  readily  supply 
themselves  with  light  or  obtain  power  from  some  other  source.  To  such 
customers  the  value  of  the  service  furnished  by  the  company  will  depend 


214  DEVELOPMENT  OF  SCIENTIFIC  RATES 

to  a  considerable  extent  on  the  probable  cost  of  supplying  themselves.  If 
the  company  is  to  supply  them,  it  is  subject  to  the  ordinary  rules  of 
qusiness  competition — it  must  meet  prices  established  by  conditions  which 
it  does  not  create  and  cannot  control,  or  not  do  the  business.  The  prices 
which  an  electric  light  company  must  thus  meet  or  not  do  business  are 
determined  not  by  an  open  market,  but  largely  by  individual  conditions, 
which  differ  widely  with  different  customers.  Had  the  company  not  taken 
the  initiative  in  offering  prices  which  have  attracted  this  business,  and 
the  customers  now  under  consideration  were  attempting  to  compel  the 
company  to  serve  them  at  prices  which  fitted  their  respective  conditions,  it 
is  probable  that  they  could  not  compel  the  company  to  serve  them  except 
at  a  price  open  to  all.  On  the  other  hand,  should  the  company  now  refuse 
to  serve  its  customers  save  at  a  uniform  price,  or  uniform  prices,  for 
lighting  and  power  respectively,  as  some  have  suggested,  it  is  equally  prob- 
able that  the  immediate  effect  would  be  a  considerable  loss  in  the  volume 
of  its  business.  The  question  arises  whether  or  not  the  existing  practice 
.  of  the  company  in  respect  to  its  prices  or  business  of  this  character  is  so 
far  inconsistent  with  its  recognized  duty  to  serve  all  without  discrimin- 
ation that  it  should  no  longer  be  tolerated. 

"In  considering  this  question  it  must  not  be  forgotten  that  the  advan- 
tage enjoyed  by  a  customer,  whose  use  of  electricity  will  warrant  the  instal- 
lation of  his  own  supply  of  electricity  or  power,  is  one  which  the  company 
cannot  prevent.  It  is  equally  to  be  remembered  that  there  is  always  a 
strong  temptation  to  the  manager  of  a  public  service,  if  unrestrained,  to 
•  maintain  a  high  rate  for  business  which  he  controls  while  making  dispro- 
portionate concessions  to  get  that  which  can  take  care  of  itself.  Experience 
is  also  making  more  and  more  evident  that  the  duty  of  one  who  undertakes 
a  public  service  must  necessarily  deprive  him  of  the  right  to  base  his  policies 
upon  many  practices  common  to  and  even  commendable  in  private  business. 

"In  reaching  out  for  additional  business  by  making  concessions  from  the 
average  rate,  it  is  plain  that  the  only  justification  for  permitting  the  con- 
tinuance of  such  a  policy  is  that  this  additional  business  will  be  for  the 
benefit  of  the  large  body  of  customers  who  must  pay  the  regular  rate.  For 
it  is  not  the  advantage  of  the  few  but  rather  the  advantage  of  the  many 
which  should  be  the  controlling  test.  In  the  opinion  of  the  Board  this 
"competitive"  business,  if  it  may  be  so  termed,  is  of  such  value  in  the 
present  development  of  the  company  that  it  may  be  of  substantial 
advantage  to  the  customer  who  must  pay  the  regular  rate.  In  fact,  the 
only  means  by  which  the  average  lighting  customer  can  hope  to  see  the 
price  to  him  materially  reduced  through  a  greater  increase  in  the  volume 
of  the  business  relative  to  the  company's  investment.  Long  use  of  a 
customer's  installation,  especially  during  parts  of  the  day  or  year  when 
otherwise  a  considerable  proportion  of  the  company's  plant  is  standing 
idle,  even  at  very  low  rates,  provided  thej^  reasonably  exceed  proper  "run- 
ning costs,"  may  yield  a  revenue  otherwise  not  available,  which  will 
materially  help  to  dilute  the  company's  general  expenses,  and  should  lead, 
as  the  business  of  the  company  develops,  to  the  steady  reduction  of  the 
price  to  the  regular  customer. 


REASONABLE  PROFIT  215 

"The  customers  who  have  just  been  under  discussion  are  now  supplied 
almost  wholly  under  the  yearly  lighting,  elevator  and  power  schedules. 
It  is  under  these  three  schedules,  and  especially  the  latter,  that  the  most 
substantial  increases  have  been  made  this  past  year  in  the  company's 
business.  While  this  is  an  indication  that  the  prices  are  sufficiently  low 
to  attract  business,  yet  the  evidence  submitted  at  the  hearings  does  not 
justify  the  conclusion  that  the  company  is  taking  business  under  these 
schedules  at  a  loss,  and  thus  imposing  a  burden  on  the  average  customer. 
Of  course,  with  respect  to  the  so-called  "competitive"  customers,  it  is  clear 
that  prices  should  not  be  determined  by  special  bargain  in  each  case,  and, 
on  whatever  basis  offered  by  the  company,  should  be  free  to  all  desiring  a 
supply  under  like  conditions.  The  demand  system,  whatever  its  faults 
in  determining  the  individual's  cost  to  the  company,  has  at  least  the  merit 
of  recognizing  the  most  essential  elements  determining  the  probable  cost 
to  the  individual  of  supplying  himself,  and  therefore  operates  to  fit  the 
price  which  the  company  must  make  to  get  his  business  to  his  actual 
conditions.  To  the  extent  to  which  this  business  is  really  competitive  it 
will  take  care  of  itself.  For  these  reasons  the  Board  makes  no  recommen- 
dations with  respect  to  these  schedules,  although  believing  that  some  read- 
justment with  a  view  to  their  simplification  upon  broader  and  more  uniform 
lines  may  be  wisely  undertaken. 

"The  Board  is  aware  of  the  danger  ot.  abuse  in  permitting  concessions 
to  some  customers  not  granted  to  all.  It  is  also  aware  that  the  terms 
"non-competitive"  and  "competitive"  cannot  be  applied  to  the  company's 
customers  with  precision,  and  that,  if  used,  they  may  not  describe  with 
absolute  strictness  the  present  non-contract  lighting  as  distinguished  from 
the  yearly  lighting,  power  and  elevator  customers.  But  the  Board  believes 
that  these  terms  recognize  as  existing  certain  economic  conditions  attending 
the  sale  of  electricity  which,  in  the  interest  of  the  many  whose  needs  and 
convenience  the  company  should  serve,  seem  to  warrant  a  continuance  of 
certain  differences  in  prices,  not  as  a  permanent  policy,  but  until  the 
uniform  rate  recommended  can  from  time  to  time  be  safely  reduced  so  low 
as  to  be  in  itself  an  encouragement  to  the  unrestricted  use  of  electricity 
for  all  purposes."- 

The  foregoing  is  an  authority  upon  the  proposition  that  rates 
should  not  be  made  to  meet  individual  conditions;  that  the  rate  to 
the  individual  should  not  be  based  solely  on  the  cost  to  the  company 
of  supplying  the  individual  (which  cost,  of  course,  includes  profit); 
but  that  all  rates  must  to  a  certain  extent  be  average  rates.  It  fol- 
lows therefore,  that  a  rate  to  a  class  cannot  include  merely  class  cost 
plus  a  fixed  percentage  of  profit;  for  the  same  reasons  that  were 
held  to  forbid  individual  rates,  indicate  that  in  fixing  class  rates  it 
is  not  necessary  to  apportion  to  each  class  the  same  percentage  of 
profit. 


Extract  From  the  Speech  of  Hon.  Joseph  W.  Bailey 

Delivered  Before  the  New  York  State 

Bar  Association 

At  Rochester,  New  York,  January  20,  1910,  on  the  Subject  of 

"The  Power  to  Regulate  Transportation  Charges  by 

Statutory  Enactment" 

"I  can  not,  however,  accept  the  doctrine  that  a  railroad  is  en- 
titled to  such  rates  as  will  yield  a  fair  return  on  the  value  of  its 
property  irrespective  of  the  value  of  its  service;  nor  will  I  agree 
that  a  railroad  can  be  required  to  render  a  service  for  less  than  a 
just  compensation  in  order  to  reduce  its  net  income  to  a  fair  return 
on  its  property.  The  power  to  regulate  the  charges  of  a  common 
carrier  was  never  conferred  on  any  government  for  the  purpose  of 
enabling  it  to  prevent  losses  or  to  limit  profits;  but  it  is  designed, 
always  and  only,  for  the  protection  of  the  people  against  overcharges. 
If  one  railroad  constructed  through  a  sparsely  settled  region  can  not 
render  enough  services  at  a  just  compensation  for  each,  to  yield  a 
fair  return  on  its  value,  that  is  the  misfortune  of  those  who  have 
invested  their  money  in  such  an  enterprise;  and  it  can  not  practice 
an  extortion  against  those  who  must  patronize  it  in  order  to  earn 
dividends  for  its  stockholders.  On  the  other  hand,  if  another  rail- 
road constructed  through  a  region  with  a  dense  population  can 
render  services  enough,  rendering  each  at  a  just  compensation,  to 
net  its  owners  fifteen  per  cent  on  their  investment,  that  is  their  good 
fortune,  and  the  legislature  has  no  power  to  reduce  the  rates  on  that 
railroad  below  a  just  compensation  in  order  to  reduce  its  dividends 
to  what  either  legislators  or  judges  may  deem  a  fair  return  on  the 
value  of  its  property. 

"I  do  not  doubt  that  in  determining  what  is  a  just  compensation 
for  the  use  of  any  property,  it  is  proper,  and  even  necessary,  for  us 
to  consider  the  value  of  that  property  in  connection  with  the  services 
which  it  may  render;  but  all  such  testimony,  however  essential  it 
may  be  to  an  intelligent  decision  of  the  case,  is  merely  a  means  to 
an  end,  and  is  not  the  end  itself.  When  a  railroad  seeks  to  condemn 
my  property  it  is  competent  for  me  to  prove  w^hat  I  paid  for  it,  or  it 


REASONABLE  PROFIT  217 

is  competent  for  the  railroad  to  do  so;  but  that  evidence,  whether 
introduced  by  the  railroad  company  or  by  me,  is  not  conclusive,  and 
it  is  admissible  only  because  it  will  tend  to  prove  what  will  be  a  just 
compensation  for  the  property  which  the  railroad  desires  to  take. 
If  I  bought  the  property  for  less  than  its  value,  the  railroad  cannot 
take  the  benefit  of  my  bargain,  nor  can  I  make  it  bear  the' burden  of 
my  bad  judgment,  if  I  paid  more  than  the  property  was  worth. 
Even  if  I  had  purchased  the  property  at  a  fair  price,  it  might,  from 
its  situation,  concurring  with  some  peculiar  circumstance,  double  or 
divide  its  price  in  a  single  year;  but  the  railroad  would  not  be  per- 
mitted to  share  my  profit  in  the  one  case  nor  compelled  to  suffer  my 
loss  in  the  other.  The  test — and  the  only  test — would  be  the  fair 
market  value  of  the  property  at  the  time  when  the  railroad  was 
seeking  to  take  it,  or  if  it  should  happen  to  be  a  property  without  a 
market  value,  then  its  value  would  be  ascertained  under  the  other 
rules  of  law;  and  as  the  railroad  must  pay  me  a  just  compensation 
for  my  property  without  reference  to  whether  that  will  net  me  a 
profit  or  leave  me  a  loss,  so  when  I  come  to  take  the  railroad's  serv- 
ice I  must  pay — and  it  can  only  demand  of  me — a  just  compensa- 
tion for  that  service  no  matter  whether  it  is  rendered  at  a  profit  or 
at  a  loss.  Exactly  as  it  was  competent  for  me  to  prove  or  for  the 
railroad  to  prove  what  my  property  had  cost  me,  so  it  is  competent 
for  the  railroad  to  prove  or  for  me  to  prove  what  its  property  has 
cost  the  railroad  company;  but  the  cost  of  my  property  and  the 
cost  of  the  railroad's  property  are  purely  evidential,  and  are  in- 
tended to  aid  us  in  fulfilling  the  constitutional  requirement  that  the 
railroad  shall  pay  me  a  just  compensation  for  my  property,  and  that 
I  shall  pay  the  railroad  company  a  just  compensation  for  its  service. 
"Many  who  concede  the  technical  correctness  of  this  rule  object 
to  it  upon  the  ground  that  it  is  almost  impossible  to  apply  it  in  prac- 
tice. It  is  undoubtedly  true  that  we  cannot  determine  the  value  of  a 
railroad  service  with  the  same  certainty  that  we  can  measure  cloth 
or  weigh  sugar;  but  it  is  equally  true  that  we  can  not  fix  values 
and  damages  with  absolute  precision  in  any  proceeding  to  condemn 
private  property  for  a  public  use.  I  have  participated  in  the  trial  of 
many  condemnation  cases,  and  I  have  seen  honest  men  and  good  citi- 
zens differ  widely  in  their  testimony  as  to  the  value  of  the  property 
actually  taken  and  the  damages  to  the  remainder  of  the  tract.  I 
have  seen  one  witness  of  high  standing  and  absolute  integrity  place 
value  and  damages  at  double  as  much  as  another  witness  of  equal 
character  and  standing  had  placed  them.     In  such  cases  I  could  well 


218  DEVELOPMENT  OF  SCIENTIFIC  RATES 

understand  how  badly  perplexed  the  jury  must  have  been  in  arriv- 
ing at  a  verdict;  but  it  never  once  entered  my  mind  that  we  ought, 
on  that  account,  to  abrogate  the  rule  which  gives  an  owner  the  fair 
value  of  his  property,  and  substitute,  on  account  of  its  simplicity, 
a  rule  giving  him  his  original  investment  with  a  fair  profit  added  to 
it.  To  reject  the  ancient  and  constitutional  rule  that  guarantees  all 
private  property  against  being  taken  for  a  public  use  without  a  just 
compensation  and  accept  this  new  and  indefensible  one  of  a  fair  profit 
on  the  investment  because  it  is  easier  of  application,  is  equivalent  to 
saying  that  we  will  adopt  an  illogical  and  unconstitutional  test  for  the 
purpose  of  relieving  ourselves  from  the  performance  of  a  very  tedious 
and  a  somewhat  difficult  duty. 

"If  those  who  are  so  ready  to  accept  a  wrong  rule  in  order  to 
escape  the  trouble  of  applying  a  right  one,  will  look  a  little  deeper 
into  this  question,  they  will  find  that  in  this  case,  as  in  all  others,  a 
departure  from  a  sound  legal  and  constitutional  principle  will  lead  us 
into  difficulties  rather  than  lead  us  out  of  them.  I  beUeve  that  I  can 
demonstrate  that  the  rule  which  we  are  asked  to  approve  because  it  is 
a  practical  one  will  produce  almost  endless  mischief.  It  will  permit 
the  most  palpable  favoritism  to  some  shippers,  and  the  grossest  in- 
justice against  others;  it  will  invite  a  discrimination  between  com- 
munities and  commodities;  and  it  cannot  be  equally  and  impartially 
applied  to  all  railroads. 

"One  serious  vice  of  the  rule  which  permits  railroads  to  charge 
any  rate  necessary  to  earn  a  fair  return  on  the  value  of  their  prop- 
erty is  that  it  treats  the  whole  schedule  of  railroad  rates  as  a  single 
question,  and  thus  permits  the  favoritism,  the  injustice,  and  the 
discrimination  which  I  have  mentioned.  If  the  railroad  is  entitled  to 
earn  a  fair  return  on  its  property,  then  the  test  would  be  whether  its 
receipts  over  and  above  its  expenditures  exceed  that  fair  return;  and 
would  not  permit  an  inquiry  into  the  reasonableness  of  each  rate, 
because  to  do  so  would  bring  us  back  to  the  very  question  of  a  just 
compensation  for  each  particular  service.  It  would,  therefore,  re- 
sult that  whenever  any  shipper  challenged  a  particular  rate  the 
railroad  could  answer  by  showing  that  after  deducting  its  expenses 
from  its  receipts  the  balance  amounted  to  only  a  fair  return  on  the 
value  of  its  property.  Will  any  intelligent  man  contend  for  a  rule 
like  that?  Do  you  think  the  railroad  could  successfully  answer  my 
complaint  that  it  was  overcharging  me  by  proving  the  value  of  its 
property,  its  expense,  and  its  receipts,  and  thus  showing  that  the 


REASONABLE  PROFIT  219 

diflFerence  between  what  it  had  taken  in  and  paid  out  left  it  only  a 
fair  return  on  its  investment?  That  might  be  entirely  true;  but  it 
might  be  true  because  some  shippers  had  been  charged  less  than 
they  ought  to  have  paid,  and  it  could  not  excuse  itself  for  over- 
charging me  by  proving  that  it  had  undercharged  someone  else. 
Let  me  state  a  concrete  case.  Will  any  intelligent  man  say  that  the 
railroad  could  answer  my  complaint  against  excessive  rates  on  my 
cattle  which  it  had  carried  from  Texas  to  Chicago  by  showing  that 
it  had  carried  cattle  from  Wyoming  to  Chicago  for  half  of  what  they 
ought  to  have  paid?  Such  an  answer  would  aggravate  rather  than 
remove  my  grievance. 

"Not  only  would  this  rule  permit  inequalities  as  between  ship- 
pers; but  it  would  encourage  discriminations  between  communities 
and  commodities.  Let  us  suppose  that  one  part  of  a  railroad  trav- 
ersed a  mineral  region  and  another  part  an  agricultural  region. 
Would  any  man  defend  its  action  either  as  a  matter  of  justice  or  as  a 
matter  of  law  if  it  should  impose  a  very  high  rate  on  the  products  of 
the  farm  and  grant  a  very  low  rate  on  the  products  of  the  mine? 
And  yet  if  the  law  only  requires  that  the  railroad  shall  have  a  fair 
return  on  the  value  of  its  property,  it  could  defend  itself  in  any 
court  by  showing  that  its  net  income  did  not  exceed  that  limit. 
What  a  mockery  of  law  and  justice  it  would  be  to  permit  the  railroad 
to  answer  the  farmer's  complaint  of  high  charges  against  him  by 
proving  low  charges  against  the  miners,  and  thus  establishing  that 
the  result  of  the  combined  charges  brought  only  a  fair  return  on  its 
investment. 

"But  the  mischief  would  not  end  with  individual  shippers  or 
classes.  It  would  disorganize  and  destroy  our  railroad  system  itself. 
Let  us  suppose  that  there  were  two  parallel  and  competing  lines 
serving  practically  the  same  territory,  and  in  many  cases  exactly 
the  same  towns  and  cities.  Let  us  suppose  that  one  was  constructed 
by  wise  and  prudent  men  under  the  most  favorable  circumstances 
and  cost  sixty  thousand  dollars  per  mile.  Let  us  suppose  that  its 
competing  line  was  built  with  equal  judgment  and  economy,  but  that 
the  cost  of  the  right-of-way  and  terminals  was  greater,  and  that  a 
proper  grade  necessitated  deeper  cuts  and  higher  fills,  thus  in- 
creasing the  cost  of  the  road-bed  until  the  actual  cost  aggregated 
eighty  thousand  dollars  per  mile.  If  these  two  roads  are  each  en- 
titled to  earn  a  fair  return  on  their  investment  and  we  estimate  that 
fair  return  at  six  per  cent,  the  one  road  must  earn  thirty-six  hundred 


220  DEVELOPMENT  OF  SCIENTIFIC  RATES 

dollars  per  mile,  and  the  other  must  earn  forty -eight  hundred  dollars 
per  mile  each  year.  Assuming  that  both  are  operated  with  equal 
economy  and  judgment,  it  must  be  obvious  to  any  man  that  the  first 
road  can  earn  its  annual  charge  of  thirty-six  hundred  dollars  per 
mile  at  a  lower  rate  on  a  given  tonnage  than  the  other  road  must 
charge  in  order  to  earn  its  forty-eight  hundred  dollars  per  mile. 
Therefore,  when  you  come  to  ^x  the  rates  so  as  to  let  each  road 
earn  its  six  per  cent  you  must  fix  a  lower  rate  on  the  cheaper  road 
and  a  higher  rate  on  the  costlier  road.  What  would  be  the  immedi- 
ate and  inevitable  result  of  such  an  arrangement.^  The  traffic  of 
that  territory  would  instantly  be  diverted  from  one  road  to  the  other, 
and  the  rates  would  soon  call  for  a  readjustment.  How  would  you 
readjust  them.^  The  cheaper  road,  on  account  of  its  increased  vol- 
ume of  tonnage,  would  be  earning  more  than  six  per  cent  under  the 
rate  which  had  already  been  fixed;  and  the  costlier  road,  in  conse- 
quence of  its  diminished  tonnage,  would  be  earning  less  than  its 
six  per  cent.  Would  you  raise  the  rate  on  the  costlier  road  and 
lower  it  on  the  cheaper  one  with  the  expectation  of  increasing  the 
income  of  the  one  and  reducing  the  income  of  the  other  .-^  You  could 
not  correct  the  inequality  that  way,  because  as  you  lowered  the  rate 
on  the  cheaper  road  and  raised  the  rate  on  the  costlier  road  you 
would  divert  still  more  tonnage  from  the  second  to  the  first,  and  it 
would  soon  become  apparent  that  no  law  could  make  the  earnings 
of  each  equal  to  the  same  return  on  the  unequal  value  of  their 
property. 

"Nor  is  this  all.  To  notify  the  railroads  that  they  can  earn  a 
fair  return  on  their  property  and  no  more,  will  destroy  the  incentive 
which  induces  railroad  managers  to  build  new  lines  and  improve 
their  old  ones.  If  men  who  manage  their  railroads  with  superior 
skill  and  judgment  can  have  no  better  profit  than  others  who  manage 
them  with  ordinary  skill  and  judgment,  we  will  soon  reach  a  point 
where  all  progress  in  railroad  management  and  development  will 
cease;  and  that  would  be  a  disaster  which  I  think  no  thoughtful 
man  is  willing  to  invite." 


Extracts  From  Testimony  of  Mr.  E.  P.  Ripley, 

President  of  the  Atchison,  Topeka  &  Santa 

Fe  Railway  Company,  Given  Before  the 

Interstate  Commerce  Commission 

Special  Examiners  at  Chicago, 

August  29  and  30,  1910 

(Testimony  Published  in  Full  Under  Title  '* Why  Railroads  Need  Higher 

Rates") 

In  the  last  ten  years  the  earnings  on  the  capitalization  (of  the 
Santa  Fe  system)  have  been  something  less  than  6  per  cent.  *  * 
*  *  Furthermore,  the  capitalization  does  not  represent  the  value 
of  the  property.  *  *  *  *  ^j^^  property  could  not  be  repro- 
duced today  for  its  capitalization.  *  *  *  *  When  an  institu- 
tion as  large  as  ours  is  standing  still,  it  begins  to  go  backward. 


We  do  not  think  that  we  ought  to  be  required  to  sell  our  bonds 
at  a  discount ;  but  if  the  people  who  have  the  money  differ  with  us  in 
that  respect,  we  are  really  helpless.  *  *  *  *  "j^j^g  ideal  con- 
dition of  course  is  that  we  should  be  able  to  sell  our  stock  at  par. 


Q.  Would  you  not  say  that  a  railroad  situated  like  the  Santa  Fe 
with  its  earning  power,  if  it  had  adequate  earnings  would  sell  its 
securities  at  par.^ 

A.  If  its  earnings  were  such  as  to  give  the  public  confidence  that 
dividends  could  be  maintained  at  a  reasonable  rate,  considering  the 
risk,  there  would  be  no  difficulty  in  selling  its  stock  at  par.  Some 
railroads  are  fortunate  enough  to  do  that.  The  Pennsylvania,  I 
think,  has  issued  no  bonds  for  a  good  many  years.  It  always  has 
obtained  the  money  for  necessary  improvements  by  selling  its  stock. 
That  is  the  ideal  condition. 

Q.  What  is  your  idea  as  to  what  improvements  should  be  made 
out  of  the  earnings  and  what  out  of  capitalization?  That  is  to  say, 
should  the  rates  in  this  case  be  increased  so  that  improvements  may 
be  made  directly  from  the  earnings? 


222  DEVELOPMENT  OF  SCIENTIFIC  RATES 

A.  Well,  in  part.  There  are  certain  classes  of  expenditure  that 
should  be  made  from  earnings  always  rather  than  from  the  sale  of 
either  stock  or  bonds. 

Q.     For  example? 

A.  Well,  for  example,  a  very  large  class  of  expenditures  that 
return  no  interest,  upon  which  there  is  no  probability  and  no  pos- 
sibility of  any  direct  return  either  in  saving  of  expenditures  or  in- 
creasing the  earnings.  In  that  class  are  the  various  restrictions  and 
improvements  demanded  by  municipalities,  where  we  are  obliged, 
for  instance,  to  elevate  our  tracks  in  the  city.  That  is  something 
the  return  from  which  financially  from  a  railroad  standpoint  amounts 
to  nothing.  It  is  of  safety  to  the  public,  convenient  to  the  public, 
and  in  a  certain  way  it  is  a  convenience  to  the  railroad;  but  the  in- 
terest on  the  cost  of  an  improvement  of  that  kind  is  ten  or  twenty 
or  thirty  times  any  benefit  that  accrues  from  it  to  the  railroads 
themselves. 


The  question  of  the  proper  distribution  of  the  burden  of  such 
expenses  between  capital  and  earnings  is  one  that  can  be  argued  on 
both  sides  and  argued  almost  indefinitely,  but  it  is  my  belief  that 
the  present  generation  should  join  in  the  expense  of  those  matters 
— that  the  railroads  should  be  allowed  to  pay  for  them  out  of  earn- 
ings in  order  that  the  entire  burden  may  not  be  put  in  capital  and 
thus    settled  on  posterity. 


A  railroad  company  certainly  should  be  sufficiently  strong 
financially  to  take  care  of  it  (obsolescence),  either  by  improvement 
— either  by  a  stated  charge  to  depreciation  or  by  improvements  made 
out  of  earnings  which  would  offset  any  depreciation  that  there  may 
be.  For  instance,  a  station  building  which  is  entirely  adequate  to- 
day or  was  entirely  adequate  when  it  was  built  fifteen  years  ago, 
becomes  inadequate,  and  it  has  to  be  torn  down  and  cast  away  and 
replaced  with  another  building.  I  have  already  said 'that  I  think 
these  things  should  be  largely,  if  not  entirely,  made  out  of  earnings, 
and  that  provides  in  a  way  for  obsolescence  or  depreciation.  The 
general  custom  has  been,  I  think,  fully  to  maintain  the  properties  out 
of  earnings  wherever  that  was  possible,  wherever  there  were  earn- 
ings enough;  and  that  full  maintenance  accompanied  perhaps  with 
some  improvement  has  been  supposed  to  take  care  of  the  deprecia- 


REASONABLE  PROFIT  223 

tion,  so  that  there  has  never  been  any  actual  charge  for  depreciation 
on  roadway  and  track.  But  whichever  way  it  is  done,  it  amounts 
to  the  same  thing;  you  either  raise  enough  money  from  the  pubUc 
to  take  care  of  those  things  out  of  earnings  or  you  should  charge 
enough  in  rates  to  take  care  of  them  by  charging  depreciation  to 
expenses. 


There  never  was  any  better  definition  of  a  reasonable  rate  than 
that  which  was  given  many  years  ago  by  somebody,  and  which  has 
been  used  as  a  byword  and  a  reproach  ever  since,  namely,  '*what  the 
traffic  will  bear."  That  is  the  best  definition  that  ever  was  given  of 
it.  That  does  not  mean  all  the  traflSc  wnll  bear,  it  does  not  mean  all 
that  can  be  extorted  or  squeezed  out  of  it,  but  what  the  traffic  will 
bear  having  regard  to  the  freest  possible  movement  of  commodities, 
the  least  possible  burden  on  the  producer  and  on  the  consumer. 


Q.  What  do  you  think  the  Sante  Fe  should  earn  on  its  invest- 
ment in  order  to  have  money  to  pay  adequately  its  stockholders,  to 
make  the  improvements  necessary,  to  borrow  money,  to  have  the 
credit  to  borrow  it  at  low  rates,  and  to  serve  the  public  to  the  fullest 
proper  capacity? 

A.  That  of  course  is  a  matter  of  judgment.  That  would  vary 
with  different  roads.  So  far  as  the  Sante  Fe  is  concerned,  I  think 
we  ought  to  earn  double  what  we  pay  in  dividends  at  least.  For 
instance,  if  we  pay  six  per  cent  in  dividends,  I  think  we  ought  to 
earn  1''2  per  cent  on  our  stock,  if  not  more;  certainly  not  less  than 
that. 

Q.  What  do  you  think  you  ought  to  pay  in  dividends  to  the 
shareholders.^ 

A.  Well,  that  is  a  matter  of  judgment.  I  do  not  think  we 
ought  to  pay  less  than  six  per  cent  in  order  to  make  the  stock  reason- 
ably attractive  and  keep  our  credit  up. 


The  question  before  the  Commission  is  primarily  what  is  the 
value  of  the  service  we  are  rendering  to  the  shipper.  Incidentally 
that  value  has  necessarily  been  enhanced  by  increased  expenses  and 
increased  wages,  by  increased  valuation,  by  incomplete  and  inade- 


224  DEVELOPMENT  OF  SCIENTIFIC  RATES 

quate  returns  on  capital.    Those  are  all  factors,  but  the  prime  factor 
is  what  is  it  worth  to  the  shipper. 


The  ideal  way  or  the  way  I  would  do  things  if  I  could,  would 
be  to  collect  from  the  public  perhaps  as  much  each  year  as  would 
equal  an  amount  of  dividends  we  paid,  and  to  invest  it  in  the 
property  without  any  additional  capitalization. 


Summary  of  Testimony  of  Mr.  James  McCrea, 

President    of    the    Pennsylvania    Railroad, 

Given  Before  the  Interstate  Commerce 

Commission,    at    Washington, 

Oct.  13,  1910 

(Copied  by  Permission  from  Railway  Age  Gazette,  Issue  of  October  21, 

1910) 

The  Pennsylvania  system  east  of  Pittsburgh  has  cost  very  much 
more  than  the  capitalization  represents.  On  that  capitalization  it 
has  never  paid  more  than  a  fair  return — less,  in  fact,  than  most  other 
characters  of  investment,  such  as  manufacturing,  mining  and  agri- 
culture. The  results  of  constant  increases  in  its  business  have  been 
distributed  either  through  reductions  in  rates,  increases  in  amounts 
paid  for  wages  and  material,  or  by  reinvestments  in  the  property  not 
capitalized.  It  has  always  been  typical  of  good  and  constantly  im- 
proved service — in  fact,  the  character  of  service  which,  if  I  under- 
stand the  x\merican  people,  they  desire  perpetuated  and  improved. 
A  railway  system  of  this  character  being  so  capitalized  and  render- 
ing a  service  which  is  not  only  of  the  highest  character,  but  satisfac- 
tory to  the  public  and  to  its  patrons,  deriving  as  it  did  in  the  year 
1909  net  earnings  to  the  amount  of  but  5.01  per  cent  of  the  amount 
actually  invested  in  the  property,  it  is  difficult  for  me  to  understand 
how  a  system  of  rates  which  secures  such  results  can  be  regarded 
as  on  too  high  a  basis. 

The  Pennsylvania  Railroad  Company  has  for  many  years  past, 
as  a  result  of  its  operations,  realized  a  substantial  surplus  in  each 
year  over  and  above  the  amount  required  to  enable  it  to  meet  its 
interest  charges  and  pay  moderate  dividends  on  its  stock  to  its 
stockholders.  This  surplus  has  varied  in  amount  from  year  to 
year.  For  the  last  ten  years  the  average  has  been  about  $1;2, 000,000 
a  year,  practically  all  of  which  has  been  expended  on  the  property 
for  the  purpose  of  enabling  the  company  to  conduct  its  operations 
more  safely,  more  efficiently  and  more  cheaply. 

Since  the  passage  of  the  Interstate  Commerce  Act  in  1887  the 
amounts  expended  on  the  property  of  the  lines  east  of  Pittsburgh 


226  DEVELOPMENT  OF  SCIENTIFIC  RATES 

out  of  the  earnings  and  from  other  sources  than  the  proceeds  of 
the  sale  of  bonds  or  stock  or  other  securities  aggregate  $262,- 
000,000,  and  the  company  was  enabled  to  provide  almost  all  of 
this  large  sum  out  of  the  surplus  earnings  derived  from  the  opera- 
tion of  its  property.  The  Pennsylvania  Railroad  and  many  of  the 
roads  embraced  in  its  system  were  built  at  a  time  when  it  was 
difficult  to  secure  capital  for  such  enterprises.  The  country  through 
which  the  roads  were  built  was  at  that  time  comparatively  thinly 
settled  and  the  business  light.  The  character  of  the  construction, 
which  was  suitable  for  the  time  and  the  existing  conditions,  was, 
to  a  large  extent,  unsuited  to  later  conditions.  The  safety  of  the 
public  and  of  employees  required  elimination  of  grade  crossings 
of  highways,  the  use  of  safety  appliances  and  the  use  of  improved 
material  and  equipment,  all  of  which  in  themselves  do  not  yield 
much,  if  any,  net  return,  and  it  was  to  meet  these  conditions  and  to 
adapt  its  road  and  equipment  to  modern  requirements  that  the 
uncapitalized  earnings  in  the  form  of  surplus  have  been  so  freely 
spent.  Had  these  earnings  not  been  available,  and  had  they  not  been 
expended  for  the  purposes  indicated,  the  Pennsylvania  Railroad 
would  today  be  a  very  different  railway  and  would  have  been  wholly 
unable  to  render  the  service  to  the  public  which  it  is  today  rendering. 
The  accumulation  of  the  surplus  earnings  which  have  been  thus 
expended  has  only  been  possible  because  the  rates  of  freight  in 
force  since  the  passage  of  the  Interstate  Commerce  Act  have  been 
sufficient  to  realize  for  the  company  amounts  in  excess  of  its  ex- 
penses, taxes,  interest  and  dividends. 

The  fact  that  these  surplus  earnings  were  being  earned  in 
each  year  has  not  been  a  matter  that  has  been  concealed  from 
the  public,  but,  on  the  contrary,  the  existence  of  the  surplus  and 
the  disposition  made  of  it  have  not  only  been  public  property,  but 
the  method  or  practice  pursued  by  the  company  in  providing  in 
part,  at  least,  for  the  necessary  additions  to  and  improvement  of 
its  property  in  this  manner  has  been  generally  and  publicly  com- 
mended and  approved.  It  is  vitally  important  that  in  the  future 
the  company  should  be  enabled  to  continue  to  pursue  the  policy 
which  has  guided  it  in  the  past,  and  to  provide  in  part,  at  least, 
for  future  additions  and  improvements  out  of  surplus  earnings. 
It  is  fairly  to  be  expected  that  the  company  will  be  required  to 
make  as  great  expenditures  in  the  future  as  it  has  made  in  the 
past.  An  enormous  amount  of  work  remains  to  be  done,  for 
which  additional  funds  will  have  to  be  secured.     The  public  of 


REASONABLE  PROFIT  227 

today  is  demanding  a  service  of  a  far  more  costly  character  than 
ten  or  twenty  years  ago  was  expected  or  desired,  and  in  order  to 
make  the  improvements  required  to  meet  the  constantly  increas- 
ing demands  of  this  character  and  to  furnish  a  service  which, 
according  to  modern  views  and  standards,  the  pubhc,  in  a  sense, 
has  a  right  to  ask  for,  large  expenditures  must  continue  to  be 
made  upon  the  property,  and  if  this  company  is  to  meet  these 
conditions  and  is  to  continue  to  progress  and  not  to  go  backward 
(because  there  is  no  such  thing  as  a  large  railway  system  stand- 
ing still),  it  must  continue  to  derive  earnings  from  its  operations, 
not  merely  sufficient  to  enable  it  to  make  a  fair  return  to  its  stock- 
holders, but  sufficient  to  earn  a  surplus  which  can  be  expended  on 
the  property  sufficiently  large  to  maintain  the  credit  which  it  has 
established. 

In  the  last  ten  years  the  Pennsylvania  Railroad  Company  has 
expended  upon  its  property  out  of  income  upward  of  $116,000,000 
and  has  also  secured,  through  the  sale  of  its  stock,  exclusive  of 
premiums,  to  the  amount  of  about  $275,000,000,  and  through  the 
increase  of  its  bonded  debt,  exclusive  of  car  trusts  ($25,000,000) 
of  about  $172,000,000.  Its  abihty  to  sell  its  stock  and  bonds  has 
been  due  to  the  fact  that  it  has  not  merely  paid  dividends  of  6 
per  cent  or  7  per  cent,  chiefly  the  former,  but  that  it  has  been 
able  to  show  at  the  end  of  the  year  large  surplus  earnings,  which 
it  has  put  back  into  the  property. 

When  investors  have  been  asked  to  purchase  its  stock  or  bonds 
the  company  has  been  able  to  show  that  it  was  then  in  receipt 
of  enough  income  to  enable  it  to  make  a  fair  return  on  the 
securities  that  it  proposed  to  issue,  even  if  the  proceeds  of  these 
securities  could  not  be  so  invested  as  to  enable  the  company  to 
derive  an  immediate  return  thereon.  In  other  words,  the  existence 
of  the  surplus  earnings  established  a  credit  which  enabled  the 
company  to  secure  the  additional  funds  necessary  to  make  improve- 
ments or  additions  as  these  became  necessary. 

What  would  have  been  the  condition  if  the  company's  earnings 
had  been  so  restricted  in  the  past  as  to  prevent  it  from  accumu- 
lating surplus  earnings  available  for  the  improvement  of  its  prop- 
erty? If  the  $262,000,000  which  has  been  thus  expended  on  the 
lines  east  of  Pittsburgh  had  been  realized  through  a  sale  of 
securities  these  securities  would  have  had  to  have  been  sold  at  a 
price  which  could  have  been  realized  for  them,  and  if  the  earn- 


228  DEVELOPMENT  OF  SCIENTIFIC  RATES 

ings  of  the  company  had  been  such  as  to  barely  cover  the  amounts 
required  to  meet  its  interest  and  dividends  on  its  then  outstanding 
securities,  the  prices  reaHzed  for  any  additional  issues  of  securi- 
ties would  have  been  such  that  the  additional  charges  to  which 
the  company  would  have  been  subjected  would  have  today  necessi- 
tated rates  higher  than  those  which  have  been  prevailing,  in  order 
to  enable  the  company  merely  to  meet  its  interest  and  dividend 
charges. 

But  there  is  another  feature  to  be  borne  in  mind  in  this  con- 
nection, and  that  is  that  a  large  part  of  the  $262,000,000  thus 
expended  upon  the  property  has  been  spent  for  purposes  which 
would  hardly  justify  an  increase  of  its  capital.  Take,  for  instance, 
the  amounts  expended  in  changes  of  line  in  order  to  eliminate 
curves  or  to  reduce  grades.  In  almost  all  cases  of  expenditures 
of  this  character  the  old  line  is  abandoned.  Take,  also,  the  large 
amounts  which  have  been  spent  in  the  elevation  of  the  railway 
through  cities  and  many  other  items  of  a  like  character.  Expendi- 
tures of  this  character,  which  do  not  result  in  any  additions  to  the 
property  which  would  tend  to  increase  its  gross  earnings  or  revenue, 
ought  not,  where  it  is  possible  to  avoid  it,  to  be  treated  as  capital 
expenditures. 

During  all  the  period  that  these  large  expenditures  were  being 
made — mainly  out  of  surplus  earnings — one  of  the  main  purposes 
that  the  company  had  in  view  was  the  reduction  in  the  cost  of 
transportation.  Throughout  this  period  the  general  trend  of  wages 
has  been  upward,  and  the  same  has  been  true  of  its  taxes  and  of 
many  other  items  which  enter  into  and  affect  operating  cost.  In- 
creased cost  resulting  from  these  features  has  been  largely  met  by 
the  reduction  in  cost  resulting  from  expenditures  made  for  this 
purpose,  and  thus  it  has  been  possible  to  avoid  constant  and  frequent 
increases  in  rates  of  freight  which  otherwise  would  have  had  to 
have  been  made  in  order  to  enable  the  company  to  meet  its  increased 
operating  cost. 

In  the  present  year  the  expenses  of  the  companies  whose  lines 
are  embraced  in  what  is  known  as  the  "Pennsylvania  lines  east 
of  Pittsburgh"  have  increased,  due  to  an  increase  in  the  rate  of 
wages  paid  to  their  employees,  between  $7,000,000  and  $8,000,000 
per  year,  and  it  is  necessary  for  this  company  in  some  way  to 
recoup  itself  for  this   additional  tax  on  its   income.     Heretofore 


REASONABLE  PROFIT  229 

in  similar  cases  this  has  been  accompHshed  partially  by  advances 
in  rates  and  partially  through  economies  resulting  from  reductions 
in  grades,  increased  hauling  capacity  of  locomotives,  increased 
capacity  of  cars  and  increased  volume  of  business. 

So  far  as  concerns  economies  which  will  result  from  reductions 
in  grades,  increased  hauling  capacity  of  locomotives  and  increased 
capacity  of  cars,  the  companies  are  today  already  practically  deriv- 
ing the  full  benefit  from  those  which  are  possible  in  this  direction, 
due  to  expenditures  heretofore  made,  for  we  have  practically  com- 
pleted our  grade  reductions  and  have  probably  reached  the  maxi- 
mum size  for  our  cars  and  engines.  And  it  is  to  be  borne  in  mind 
in  this  connection  that  we  are  now  largely  unable  to  secure  the 
benefit  of  increased  economies  resulting  from  larger  engines  and 
cars  and  reduced  grades  with  respect  to  our  preference  freight  trains, 
in  which  the  merchandise  class  traflfic  as  a  rule  is  transported,  due 
to  the  fact  that  the  amount  hauled  by  these  trains  is  limited  by 
higher  speed  and  the  maximum  grades  over  which  they  must  pass, 
this  being  necessary  in  order  to  avoid  the  breaking  up  of  the  trains 
at  transfer  points. 

For  the  last  three  years  there  has  been  practically  no  growth 
in  business.  The  records  of  1910  will  show  that  the  business  of 
that  year  is  below  that  of  1907.  I  do  not  mean  that  it  should 
be  inferred  from  this  that  there  is  not,  in  my  opinion,  going  to 
be  any  future  growth  in  business,  but  east  of  the  Mississippi,  at 
least  in  my  judgment,  it  is  going  to  be  at  a  markedly  slower  rate 
than  in  the  past,  and  with  that  growth  will  probably  come  a  dimin- 
ishing length  of  haul,  thereby  tending  to  reduce  the  gross  earnings 
of  the  companies.  But  even  if  our  gross  earnings  are  to  continue 
to  grow  as  the  result  of  growth  in  business,  the  additional  net 
earnings  that  will  be  derived  from  the  increased  business  will  in  all 
probability  fall  very  far  short  of  making  good  the  additional  cost 
put  upon  the  companies  by  the  wage  increase. 

That  this  is  true  is  largely  demonstrated  by  the  results  of  the 
company's  operations  for  the  five  months  following  the  advance 
in  wages.  In  these  five  months  the  gross  earnings  of  the  lines 
east  of  Pittsburgh  increased  about  $6,700,000,  while  the  net  earn- 
ings (including  in  the  expenses  expenditures  heretofore  made  for 
additions  and  betterments,  in  order  to  enable  a  comparison  to  be 
made  with  last  year,  when  expenditures  of  the  same  character  were 
also  included  in  operating  expenses)  decreased  about  $3,000,000. 


230  DEVELOPMENT  OF  SCIENTIFIC  RATES 

Treating  these  months  as  typical  months — and  there  is  no  reason 
why  they  should  not  be  regarded  as  such — and  extending  the  figures 
so  as  to  embrace  a  year's  business  on  this  basis,  the  result  would  be 
that  with  increased  gross  earnings  of  about  $16,000,000,  there  would 
be  a  decrease  in  the  net  earnings  of  about  $7,200,000.  The  results 
of  the  five  months'  operation  already  referred  to  have  also  shown 
that  (treating  again  the  expenditures  heretofore  made  for  the  addi- 
tions and  betterments  as  part  of  the  operating  expenses,  in  order 
to  enable  a  comparison  to  be  made),  the  operating  ratio  has  risen 
from  69.70  per  cent  in  1909  to  75.51  per  cent  in  1910,  an  increase 
of  almost  6  per  cent.  There  is  no  reason,  in  my  judgment,  for 
expecting  that  further  increases  of  gross  earnings  will  tend  materi- 
ally to  reduce  this  operating  ratio,  except  to  the  extent  to  which 
increased  rates  of  freight  will  tend  to  do  this.  The  company  will 
therefore  in  the  future  be  obliged  to  expend  for  operating  expenses 
probably  not  less  than  75  per  cent  of  any  increased  earnings  which 
it  may  derive,  but  the  25  per  cent  which  will  be  thus  left  will 
not  represent  surplus  earnings;  thus,  for  example,  gross  earnings 
of  the  Pennsylvania  Railroad  Company  in  the  year  1909  exceeded 
those  for  the  year  1900  by  about  $66,000,000,  the  operating  expenses, 
including  taxes,  increased  $52,000,000  and  the  net  earnings  about 
$14,000,000. 

But  in  this  same  period  the  investment  of  the  company  in  the 
property  from  which  this  income  was  derived  had  increased  to 
the  extent  of  $288,000,000.  Interest  on  this  amount  at  the  rate 
of  6  per  cent  would  be  more  than  $17,000,000,  so  that  of  the 
increased  earnings  of  1909,  which,  as  has  already  been  said, 
amounted  to  $66,000,000,  $52,000,000  was  absorbed  by  operating 
expenses  and  taxes,  leaving  $14,000,000  net  earnings,  or  $3,000,000 
less  than  the  interest  on  the  amount  necessary  to  secure  them. 

In  my  judgment,  therefore,  it  would  be  wholly  unsafe  to 
assume  that  the  company  will,  ^s  a  result  of  the  growth  of  its 
business,  be  enabled  to  recoup  itself  for  the  depletion  in  its  surplus 
revenue,  which  is  certain  to  result  from  a  continuance  of  the  present 
operating  cost.  Under  these  conditions  I  feel  that  it  is  essential, 
in  the  interest  of  the  public  and  of  shippers,  as  well  as  of  the  railway 
company  itself,  that  it  should  be  permitted  to  secure  through  an 
advance  in  rates  the  amount  which  represents  its  additional  outlay 
on  account  of  the  advance  in  wages  in  order  that  its  surplus  earnings 
may  continue  at  approximately  the  rate  at  which  they  have  been 


REASONABLE  PROFIT  231 

running  in  the  past.  It  will  require  the  expenditure  of  more  than 
these  surplus  earnings  to  enable  the  company  to  keep  pace  with  the 
demands  of  the  public  and  of  its  shippers,  and  unquestionably  addi- 
tional capital  must  be  secured  in  the  future.  If  we  are  to  obtain 
this  we  must  not  only  be  in  a  position  to  make  a  fair  return  on  it, 
but  we  must  be  able  to  show  a  margin  of  safety  in  our  earnings. 

I  believe,  generally  speaking,  that  what  I  have  said  in  regard 
to  the  Pennsylvania  Railroad  as  to  the  necessity  for  the  rate  advance 
is  equally  true  of  almost  all  railways  in  the  United  States,  certainly 
those  which  are  conservatively  managed  and  which  are  endeavoring 
to  give  the  public  such  a  service  as  they  have  a  right  to  expect. 


JOHN  BORNMAN  &  SON,   DFTROIT 


wtwwtodIIS^^  use 

OMSK  FROM  WHICH  BORROWBD 

^  ,  ,    LOAN  DEPT 


U.retAr..f6i' 


vm^^J-^^fS^,     ^ 


gyo, 


%. 


741436 


UNIVERSITY  OF  CAUFORNIA  UBRARY 


